Forecasting and Monetary Policy Analysis in Low-Income Countries: Food and Non-Food Inflation in Kenya

64 Pages Posted: 9 Apr 2013

See all articles by Michal Andrle

Michal Andrle

International Monetary Fund (IMF)

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division

Armando Morales Bueno

International Monetary Fund (IMF) - Monetary and Exchange Affairs Department

Rafael Portillo

International Monetary Fund (IMF)

Jan Vlček

International Monetary Fund (IMF)

Date Written: March 2013

Abstract

We develop a semi-structural new-Keynesian open-economy model, with separate food and non-food inflation dynamics, for forecasting and monetary policy analysis in low-income countries and apply it to Kenya. We use the model to run several policy-relevant exercises. First, we filter international and Kenyan data (on output, inflation and its components, exchange rates and interest rates) to recover a model-based decomposition of most variables into trends (or potential values) and temporary movements (or gaps) — including for the international and domestic relative price of food. Second, we use the filtration exercise to recover the sequence of domestic and foreign macroeconomic shocks that account for business cycle dynamics in Kenya over the last few years, with a special emphasis on the various factors (international food prices, monetary policy) driving inflation. Third, we perform an out-of-sample forecast to identify where the economy — and therefore policy — was likely headed given the inflationary pressures at the end of our sample (2011Q2). We find that while imported food price shocks have been an important source of inflation, both in 2008 and more recently, accommodating monetary policy has also played a role, most notably through its effect on the nominal exchange rate. The model correctly predicted that a policy tightening was required, although the actual interest rate increase was larger. We discuss implications for the use of model-based policy analysis in low income countries.

Keywords: Economic forecasting, Kenya, Food imports, Inflation, Monetary policy, Low-income developing countries, Forecasting models, Monetary Policy, Forecasting, Food Prices, inflation, Low-Income Countries, monetary policy, central bank, relative price, relative prices, real interest rates, inflation target, real interest rate, inflationary pressures, foreign exchange, price inflation, inflation rate, aggregate demand, monetary conditions, monetary fund, monetary policy rule, inflation dynamics, inflation rates, increase in inflation, money growth, money supply, inflation objective, inflation targeting, rational expectations, monetary aggregate, monetary economics, monetary transmission, open marke

JEL Classification: E52, E58, F47, O23

Suggested Citation

Andrle, Michal and Berg, Andrew and Morales, R. Armando and Portillo, Rafael and Vlcek, Jan, Forecasting and Monetary Policy Analysis in Low-Income Countries: Food and Non-Food Inflation in Kenya (March 2013). IMF Working Paper No. 13/61, Available at SSRN: https://ssrn.com/abstract=2247222

Michal Andrle (Contact Author)

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Andrew Berg

International Monetary Fund (IMF) - Developing Country Studies Division ( email )

700 19th Street NW
Washington, DC 20431
United States
202-623-8843 (Phone)
202-589-8843 (Fax)

R. Armando Morales

International Monetary Fund (IMF) - Monetary and Exchange Affairs Department ( email )

700 19th Street NW
Room 6-548
Washington, DC 20431
United States
202-623-8476 (Phone)

Rafael Portillo

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

Jan Vlcek

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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