Relationship between openness and inflation in Kenya: Testing Romer hypothesis using Autoregressive Distributive Lag

Abstract

Romer (1993) formulated the hypothesis that the relationship between inflation and openness is negative. The objectives of this paper are to determine if openness has any effect on inflation in Kenya and to establish the nature of the relationship between openness and inflation in Kenya. This paper contributes to the literature by examining the relationship between openness and inflation in Kenya by applying Autoregressive Distributed Lag (ARDL) to establish the long run relationship. The ADF test is conducted to determine the stationarity of the data while the ECT is used to determine the short run dynamics of the model and the deviation to equilibrium. . The other variables used in the study include: money supply, real interest rates and real GDP for the period of 1975- 2015. Based on the findings, there exist a negative relationship between inflation and openness in Kenya which supports the Romer (1993) hypothesis. However, this relationship is not significant. This implies that the closed economy explanation for the inflationary process remains valid.