The impact of oil price shocks on inflation
Kiilu, Nicole Nduku
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The issue that this study addresses is the lack of stability of consumer prices in Kenya. According to the National Energy and Petroleum Policy Report (2015), the fluctuating international prices of petroleum products and the volatile foreign exchange rates have led to unpredictable consumer prices within the country. The resulting cost-push inflation has led to an unsustainable increase in the cost of living from 2010. The purpose of this study is to investigate the impact of international oil price changes on inflation in Kenya. This will be done using a Vector Autoregressive Model and the model will control for exchange rates and interest rates. The study uses monthly data from 2000 to 2016. The variables examined are: domestic price levels, Murban crude oil prices, the Kenyan to US dollar exchange rates and the 91 day Treasury bill interest rates. The results indicate a positive correlation effect of oil price on inflation but no long run co-integrating relationship between these variables. The results also indicate the absence of an asymmetrical relationship between oil prices and inflation in Kenya. Lastly the results found that oil price had a uni-directional effect on domestic prices. Oil price also Granger-caused domestic prices indirectly through the exchange rate; that is, as oil price increases, this increases import prices and hence domestic prices. These results are useful in determining which relevant measures can be put in place by policymakers to address the problem of inflation and also add to the body of knowledge that seeks to understand the intuitive connection between oil price fluctuations and inflation rate.