Abstract: It is now widely agreed among economists, policy makers and central banks that the main objective of monetary policy is to keep low inflation rate which is regarded as a measure of macroeconomic stability. To achieve this objective, inflation has to be well managed and a need to understand its determinants is at utmost important. Monetary policy and financial stability report (2016). As in other countries, the findings in Rwanda reveal mixed results on inflation and its determinants. This is mainly due to a range of conventional views about the appropriate measure of inflation and also due to a disparity between countries (developed and developing countries). This raises concern among policy makers and requires an investigation as to why inflation continue to increase despite their efforts to control main drivers of inflation in order maintain price stability. Given this backdrop, there is need to establish the determinants of inflation in Rwanda. This has form the general objective of the study. The specific objectives of this study were to examine the effects of money supply on inflation; to investigate the effects of exchange rate on inflation; to determine the effects of GDP on inflation and to establish the effects of oil prices on inflation. Findings clearly suggest that a unit change in Money supply increases the inflation; a unit change in Exchange rate decreases the inflation; a unit change in GDP certainly and significantly increases the inflation and that a unit change in the Oil price decreases the inflation by certain measures. Though the econometric model used had been found to fit the data, (with R-square = 94.45%), all along, serial correlation or simply heteroskedasticity of the error terms has been found to exist for the time series that were used. With respect to the level of elasticity of the variables under study, both exchange rate and money supply had larger coefficients that the GDP and Oil price. Unit root test performed also suggested stationarity at different lags for each time series. Particularly the money supply time series was found to be more stable than any of the three remaining; GDP time series was stationary only at lag 0 and at lag one; inflation and oil price time series were found to be stationary only at lag 7 and 17 respectively. Interestingly, at lag 18, all-time series considered in the model had an explosive behavior. Through the Vector autoregressive test, impulse-response dynamics of the time series in the model was performed. Findings suggest strongly the shocks on inflation causes responses of different magnitude on the independent variables. When considering shocks from the predictors, it has been found particularly that shocks from exchange rate causes a huge oil price response. This is in line with the economic dynamism that has been observed in Rwanda. Stability of VAR model under study has also been examined and findings revealed a rather non-stable VAR model, if the natural logarithm of the economic variable is considered. When transformed into their difference state, finding reveals a completely stable VAR model. Co-integration has been also performed. Findings suggested existence of only two possible co-integration vectors that can explain the long run economic effects, namely the inflation and money supply. Thus, not neglecting other factors, findings of the current research strongly suggest that at the fore front of the determinants of inflation is primarily money supply in the economy. Hence, sound an adequate monetary policy has evidently more impact on inflation than any other determinant considered in this work.
Keywords: Money Supply, exchange rate, Inflation, Gross Domestic Product, Consumer Price Index.
Title: AN EMPIRICAL ANALYSIS OF THE DETERMINANTS OF INFLATION IN RWANDA (2006-2015)
Author: Noella Nyishimente, Dr. Jaya Shukla, Dr. Patrick Mulyungi
International Journal of Management and Commerce Innovations
ISSN 2348-7585 (Online)
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