Inflationary Pass-through Effects of Oil Price Shocks on the Zambian Economy (1985–2019)

Abstract

This study explores the effect of disaggregated oil price shocks on Zambia’s historic headline inflation rates. To quantify the contemporaneous impact of oil price shocks on inflation, a Structural Vector Autoregressive Model (SVAR) is utilised, which is supplemented with Impulse Response Functions (IRFs), Granger Causality Tests and Forecast Error Variance Decomposition (FEVD). After satisfying the cointegration criteria, long-run relationships are examined using the Vector Error Correction Model (VECM).The findings show that decomposed oil price shocks do not have a short-run contemporaneous impact on inflation at the 5% level and that oil price shocks do not Granger-cause inflation. The insignificance of the short-run inflationary pass-through effect is attributed to Zambia’s historic price controls, fuel subsidies, exchange rate controls and increased credibility of monetary policy. Notably, of the three types of oil price shocks, FEVD results show that global aggregate demand shocks are attributed for the largest variation in Zambia’s inflation rates, i.e. 1.8%. Long-run analysis using VECM shows that global aggregate demand and oil supply shocks both have a significantly negative long-run impact on inflation, while oil-specific demand shocks have a significantly positive impact on inflation. The speed of adjustment of inflation back to equilibrium after a short-run deviation is shown to be significant and monotonic.