The relationship between inflation and Economic growth in Zambia (1980-2011)
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The study on the relationship between economic growth and inflation has attracted attention world over by researchers and policy makers. A high and sustained economic growth with low and stable inflation is the central objective of most policy makers. However, previous studies on the relationship between inflation and economic growth have revealed the complexity of this subject. These studies show that there might be no relationship, there might be a negative relationship or there might be a positive relationship between inflation and economic growth. Other studies further show that these variables might be related either in the short-run or long-run or both, with no consensus on the direction of causality. Therefore, the ambiguity of the relationship between inflation and economic growth as portrayed in both theory and empirical studies warrants an investigation into this matter in the context of Zambia. This is further qualified by the fact that, there is no study that depicts the exact relationship between these two variables in the context of Zambia for the period under study and years earlier. The main purpose of this study is to ascertain the nature of the relationship between inflation and economic growth in Zambia. In doing so, the study seeks to unravel the short-run and long-run dynamics between inflation and economic growth as well as establishing the nature of causality. The study reviews both theoretical and empirical aspects of inflation-economic growth relationship. Time series analysis involving stationarity tests, cointegration tests, Granger causality tests and vector autoregressive analysis (VAR) are employed. Growth in the logarithm of the Consumer Price Index (CPI) is used to measure inflation and growth in real GDP as a measure of economic growth to examine the relationship. The study covers a period from 1980 to 2011 and the data is used as annual time series. The study finds no cointegration between inflation and economic growth. The non-existence of cointegration implies that there is no stable long-run equilibrium relationship between inflation and economic growth. They have different trend processes and cannot stay in a fixed long-run relationship. However, the VAR analysis reveals that inflation significantly and negatively impacts economic growth in the short-run. The study further reveals that there is unidirectional Granger causality running from inflation to economic growth. These results concur with several studies reviewed; that inflation is and has been detrimental to economic growth. Impulse response analysis also shows that a one-standard-deviation shock in inflation changes GDP growth by about one percentage point in the current period. One important policy implication of our study is that, by knowing the past values of GDP, we cannot predict what inflation rate will be in future. On the contrary, the past values of inflation help predict future rate of GDP. Furthermore, having established that it is inflation that causes GDP and this happens in a negative way, policy makers should worry more about controlling inflation in the short-run. Any measure that is likely to fuel inflation in the short-run will also depress economic growth. Policy makers should also aim at achieving the highest GDP growth rate possible, as doing so will not be a trade-off by introducing short-run inflationary pressures in the economy.