The dynamics of inflation in Tanzania: a multivariate time series analysis.

This study developed an error correction model with the aim of analyzing the behavior of prices in Tanzania during 1966-2000. In estimating the model, we first test for cointegration in the monetarist model of inflation, using the Johansen procedure. The cointegrating vector is then included in an autoregressive distributed lagged model, and a general-to-specific procedure is applied to obtain a parsimonious, empirically constant, error correction model. The data used in the analysis exhibit normal distribution except price and the rate of interest. However, all the series were found to be stationary after first differencing, except interest rate, which became stationary at levels. Analysis from model estimation showed that, in the long run inflation emanates from movements in money growth, interest rate, exchange rate and gross domestic product. Furthermore, in the long run, inflation is positively related to both money supply and exchange rate, and negatively related to income. The dynamics of inflation is also influenced by external shocks such as war, droughts and oil crises. The vector autoregressive (VAR) results show that variables in the rate of inflation is dominant in accounting for its own innovations, (36 percent), aided by shocks in exchange rate, money growth, interest rate and income. However, exchange rate was found to be most important variable accounting for about 33 percent of the innovations in the price level. Money growth and interest rate account for about 18 percent and 8 percent respectively. Shocks to income account for only about 4 percent variations in the price level. In terms of policy implications Tanzania like any other developing countries can easily absorb the problem of inflation by practicing restrictive monetary policy and at the same time taking into account innovational effects that may arise from other related macroeconomic variables. Furthermore, production of output should be raised to bring down the rising domestic prices.