Money and Other Determinants of Inflation: The Case of Tanzania

By Ndanshau, Michael O. A. | Indian Journal of Economics and Business, September 2010 | Go to article overview

Money and Other Determinants of Inflation: The Case of Tanzania


Ndanshau, Michael O. A., Indian Journal of Economics and Business


Abstract

This paper seeks to establish the relative importance of money and other factors in explaining inflation in Tanzania. The analysis was based on quarterly data for the 1967-2005 period. Both long run regression results failed to establish existence of positive one-to-one correspondence between growth rates of three monetary aggregates (M1, M2, M0) and (headline) inflation in Tanzania. The lack of the one-to-one correspondence as predicted by the Quantity Theory of money also emerged form estimated dynamic autoregressive distributed lag (ADL) error correction model (ECM). Instead, other factors, particularly growth in real income, were found to exert the expected depressive influence on inflation. This finding underscores the importance of the demand for money in explaining inflation. Other important structural factors found to influence inflation in Tanzania include nominal exchange rate and inflation inertia. In aggregate the long run influence of changes in money was found to be very small if compared to that exerted by structural factors. This suggests limitations to monetary policy and importance of structural factor in explaining the dynamics of inflation in Tanzania. On account of theoretical controversies and innovations that have characterized inflation theory to-date coupled with methodological issues of interest, more research on inflationary process in Tanzania is called for to anchor or better the results of this paper.

JEL Classification Numbers: E31, E52

Keywords: Inflation, monetary policy, econometrics, developing countries.

I. INTRODUCTION

In 1995 the government of Tanzania amended the 1965 central bank charter through the central bank by the Bank of Tanzania Act, 1995, that revived use of indirect monetary policy instruments. Later in 2006, the 1995 Act was also amended, due regard having been, among others, to "provide for more responsive regulatory role of the Bank of Tanzania (BoT) in relation to the formulation and implementation of monetary policy" (United Republic of Tanzania, 2006, p. 119). One theoretical and policy issue of interest in the two amendments is categorical declaration of "the primary mission of the bank "to formulate, define and implement monetary policy directed to the economic objective of maintaining price stability, conducive to a balanced and sustainable growth of the national economy of Tanzania" (United Republic of Tanzania, 2006, p. 123; Bank of Tanzania, 2001, p. viii).

Delivery by the BoT as per its entrusted mission requires a good understanding of the determinants of inflation in Tanzania. It is evident from available anecdotal evidence that the BoT only subscribes to an often quoted view held by Friedman (1960) that "inflation is always and everywhere a monetary phenomenon"; and, as a result, "no country can succeed in "stemming inflation without adopting measures directed at restraining the growth of the stock of money" (p. 2). Some studies on Tanzania, mostly carried out prior to the launch of economic reforms in mid-1986, show that inflation is not entirely a monetary phenomenon. (2) Rather, they found that structural factors also enter significantly in explaining inflation but mostly during the period prior to the launch of economic reforms in mid-1986. In this regard, this paper tests the conventional null hypothesis that "inflation is mainly a monetary phenomenon" against an alternative hypothesis that "structural factors matter" more in explaining short and long run inflation dynamics in Tanzania.

Apart from this introductory section, Section 2 presents the monetarists' theory of inflation and reviews related empirical literature. Section 3 presents a descriptive analysis of the developments of inflation in Tanzania during the sample period. The usual econometric model and discussion of data are presented in Section 4. Section 5 presents, discusses and compares the econometric results. Section 6 concludes, highlighting policy implications of the findings and areas for further research.

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