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Working Paper 163 - Food Prices and Inflation in Tanzania
26/12/2012 18:53
Working Paper 163 - Food Prices and Inflation in Tanzania
This paper presents an econometric model of headline Tanzanian inflation and its principal components for the period since 2000.  Inflation is modeled in terms of deviations from a set of ‘anchors’ reflecting long-run demand-side and monetary determinants, on the one hand, and supply-side and open economy factors on the other.  Five main conclusions derive from our analysis. In the last five years Tanzania, along with the other major economies of East Africa, has experienced a period of high and volatile inflation.  In mid-2008, year-on-year headline inflation edged above 10 percent per annum for the first time since the early 1990s, and while it dropped back to low single digits in 2009 it rose again sharply towards the end of 2010, reaching close to 20 percent per annum in the final quarter of 2011. Much of this rise in inflation and inflation volatility reflects developments in the global economy, most obviously the sharp rises in global food and fuels prices in 2008 and again in 2011. With food accounting for 51% of the consumption basket in Tanzania and energy and transport costs accounting for a further 9 percent each, these global developments may be expected to have a powerful impact on overall inflation, both directly and, in the case of energy prices, indirectly through the high share of transport and distribution costs in retail prices. First, money growth and hence the stance of monetary policy matters for inflation both in the long run and in the short run.  The transmission from the monetary stance, through aggregate demand, to headline inflation is principally through core inflation but not exclusively so; monetary or demand-side effects also feed food and fuel price inflation, particularly in the short run.  Second, however, the principal component of overall inflation -- food price inflation -- is predominantly driven by supply-side factors including both domestic agricultural output shocks and by the pass-through from world prices for food and fuel.  The inflation transmission from world food prices is, however, relatively weak and attenuated, and is much stronger when world prices rise than when they fall.  This is consistent with an environment in which retailers and distributions enjoy significant market power and are able to pass on price rises to consumers but to cushion their own margins when world prices fall. Third, the effect of domestic supply conditions on food price inflation points to the asymmetric effects of trade policy in Tanzania; while food imports appear to respond reasonably rapidly to domestic production short-falls, the capacity to export surplus food production is much more muted so that market adjustment in this case occurs through falling prices, other things equal.  This result has important implications for trade policy and production incentives in agriculture although, as noted below, a much closer analysis of cross-border prices is required before firm policy conclusions can be drawn. Fourth, headline inflation exhibits strong seasonality, consistent with weak price-stabilizing effects of trade and incomplete storage.  Non-food inflation is, by contrast, broadly non-seasonal.  Finally, prices in Tanzania in general are flexible, more so for the food and energy sub-components but even in the traditionally sticky-price domain of core inflation there is little evidence of inflation persistence overall.  Some channels of price adjustment are take time – notably the effects of monetary disequilibrium -- but in general inflationary shocks dissipate rapidly with half-live being little more than one month. The analysis points to three priority areas for further research.  First, a better understanding of the supply-side (cost-push) determinants of core inflation is required.  Second, and related, the role of movements in the nominal exchange rate remains poorly understood.  Once the effects operating through the pass-through from world food and fuel prices – and the role it plays in determining the equilibrium demand for money – there appears to be only a surprisingly weak independent short-run role for the nominal exchange on any of the principal components of inflation.  Finally, the concept of ‘world food prices’ used throughout this analysis needs to be revisited to reflect the impact of cross-border food prices, particularly in Kenya to the North and Zambia and Malawi in the South West of the country. At present, our models include measures of the deviation of domestic food and fuel prices from world price indices derived from the World Bank global commodities database.Read more
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