Inflation dynamics and agricultural supply shocks in Uganda

Abstract

Purpose The purpose of this paper is to develop an empirical model for inflation in Uganda, highlighting the role of supply side factors in the domestic agricultural sector. Design/methodology/approach The adopted empirical analysis is based on a single equation model that exploits cointegration techniques and general-to-specific modeling. The analysis controls for historical, seasonal as well as policy factors such as the effects of the global financial crisis, change in monetary policy regime to inflation targeting and monthly seasonal effects. Findings Results indicate that disequilibrium in the money, external and agricultural sectors feed into the Ugandan inflation process in the long run. However, the external and monetary sectors have larger long-run effects on inflation than the agricultural sector. Other factors that influence inflation in the short run include: inflation inertia, real output, money supply, exchange rate movements, foreign prices, monetary policy instruments and seasonal factors. In addition, the paper shows that the inflation-targeting policy has been successful in containing inflationary pressures. Practical implications These findings suggest that in the long-run monetary policy will continue to play an important role in managing Ugandan inflation through money demand management. The inflationary effects of agricultural supply shocks could be mitigated with appropriate domestic actions. In particular, fiscal policy that targets increased productivity and efficiency in agriculture through increased focus on production, irrigation, storage and transportation could reduce the effects of agricultural supply variability on inflation. In addition, policies intended to improve economic growth by expanding total output, control money supply growth and maintaining stability in the foreign exchange markets will help to reduce inflation. Social implications Studies of inflation and its determinants have dominated macroeconomic debates in the past decades because of the importance of price stability in economic growth and household welfare. The major conclusions from those studies are that: high inflation is detrimental to investment and growth; erodes the purchasing power; reduces household welfare; and exacerbates income inequality. Moreover there is a growing strand of literature establishing a causal link between inflation and conflict. Particularly for agricultural households, the effects of inflation are usually felt through the increase in food prices with implications for consumption and food security. These findings indicate the important macro and social implications of inflation. By focusing on the importance of agricultural supply shocks, the paper contributes to a better understanding of the drivers of inflation and how the macro and social effects can be addressed. Originality/value The major contribution of this paper is to try and model an equilibrium relationship in the domestic agricultural sector rather than using proxies such as an output gap measure or rainfall.