Inflation Dynamics And Food Prices In An Agricultural Economy: The Case Of Ethiopia

Abstract

Ethiopia has experienced a historically unprecedented increase in inflation, mainly driven by cereal price inflation, which is among the highest in Sub-Saharan Africa. Using monthly data over the past decade, we estimate error correction models to identify the relative importance of several factors contributing to overall inflation and its three major components, cereal prices, food prices and non-food prices. Our main finding is that, in the long run, domestic food and non-food prices are determined by the exchange rate and international food and goods prices. In the short to medium run, agricultural supply shocks and inflation inertia strongly affect domestic inflation, causing large deviations from long-run price trends. Money supply growth affects food price inflation in the short run, though excess money supply does not seem to drive inflation in the long run. Our results suggest a challenging time ahead for Ethiopia, with the need for a multipronged approach to fight inflation. Forecast scenarios suggest monetary and exchange rate policies need to take into account the cereal sector, as food staple growth is among the key determinants of inflation, assuming a decline in global commodity prices. Implementation of successful policies will be contingent on the availability of foreign exchange and the performance of agriculture.

International to Domestic Price Transmission in Fourteen Developing Countries during the 2007–8 Food Crisis

“…In their empirical studies, Minot (2011) and Ulimwengu, Workneh, and Paulos (2009) find no long-run relationship between Ethiopian maize, sorghum, or wheat markets. In contrast, Loening et al (2009) andConforti (2004) do find long-run co-integration between the Ethiopian and international grain prices. Admassie (2013) argues that the Ethiopian crisis was primarily caused by long-running domestic factors, such as increasing grain demand due to economic growth and more well-developed social safety nets, stagnating grain supply, and inflationary monetary policy.…”

“…Minot 2011) have found that these countries are poorly integrated with the world markets. In contrast, even isolated markets, like the maize market in Ethiopia, appear to display some long term relationship with the international markets (Loening, Durevall, and Birru 2009). In general, we are likely to find that domestic prices in all countries are determined by a mix of domestic factors as well as transmission from international prices.…”

Is There a Case for Formal Inflation Targeting in Sub-Saharan Africa?

“…They also show that changes in rainfall directly affect inflation -another supply-side factor. been linked to agricultural supply shocks and strong inertial dynamics (Loening, Durevall, Birru, 2009). Others have documented the importance of exchange rate passthrough and the price of imports in influencing inflationary dynamics.…”

Is There a Case for Formal Inflation Targeting in Sub-Saharan Africa?

“…These studies indicate that supply-side factors play a role in determining inflation dynamicsnegative shocks to economic growth or lower estimated values for potential GDP raise inflation rates. been linked to agricultural supply shocks and strong inertial dynamics (Loening, Durevall, Birru, 2009). Others have documented the importance of exchange rate passthrough and the price of imports in influencing inflationary dynamics.…”