The impact of oil price changes on inflation in Kenya for the period 1996-2011

Abstract

This paper analyzed the impact of oil price changes on inflation in Kenya during the period 1996Q1 to 2011Q4, a period characterized by a world economic crunch, increased investment and development activities and a liberalized environment. Oil prices have had an upward trend in the recent past and this has led to the high energy bills which have eaten up of after-tax income of the consumers leading to high cost of living. The paper uses the Johansen Cointegration Analysis and the Vector Error Correction Model to analyze time series quarterly data. The results of the regression showed that the signs of the coefficients of all variables were as expected. Exchange rate, money supply and oil prices were found to be statistically significant while interest rate and GDP were concluded to be statistically insignificant. However in the short-run, GDP lagged once was found to have an effect on inflation, is statistically significant and carries the expected negative sign. Further, interest rate lagged once is also statistically and carries a positive sign unlike in the long-run which could be caused by increase in interest rates by CBK that leads to temporary rise in inflation. Nominal exchange rates both current and lagged have positive coefficient and in agreement with long-run results. Money supply, current and lagged twice and oil prices current and lagged once are positively significant indicating that in the short-run increases in oil prices and money supply would lead to rise in inflation. Several policy implications have been put forward from the findings of the study, which should be adopted in Kenya to mitigate the effects of oil price shocks on inflation.