Inflation Dynamics in Zambia
This study assesses the drivers of overall inflation in Zambia over the period 1994q1- 2019q4. A single-error correction model is used in which the underlying determinants of both food and non-food components of inflation as well as supply constraints are incorporated in the overall inflation equation. The empirical results show that, in the long-run, the sources of overall inflation are determined in the external sector market where the exchange rate and world non-food prices drive domestic prices. In the short-run, overall inflation is influenced by the depreciation of the Kwacha, increases in energy prices, imported inflation from South Africa, and increases in maize prices (supply constraints). Overall inflation exhibits persistence and seasonality. Further, the two sub-components of inflation display different characteristic behavior. This underscores the importance of employing a disaggregated approach in modelling inflation to improve information content and policy response. Three policy lessons can be drawn from these empirical results. Firstly, the dominant influence of the exchange rate on overall inflation and its sub-components requires a firm policy strategy to maintain stability in the exchange rate. Secondly, expanding and diversifying the manufacturing base to limit the current high dependence on imports of final consumer and capital goods from South Africa should be prioritised. Finally, the role of supply shocks—evident in the impact of maize prices on inflation—necessitates immediate significant reforms in the agriculture sector to boost productivity through the use of modern techniques such as irrigation in order to reduce dependence on rain fed practices.
- Monetary Economics