2.3 EMPIRICAL FRAMEWORK
Currently, the quantity theory of money is widely accepted as
an accurate model of inflation in the long run. Consequently, there is now
broad agreement among economists that in the long run, the inflation rate is
essentially dependent on the growth rate of money supply. However, in the short
and medium term inflation may be affected by supply and demand pressures in the
economy, and influenced by the relative elasticity of wages, prices and
interest rates (Federal Reserve Board, July 2004)
Sargent and Wallace believe that budget deficit could increase
inflation because of their preponderance in the growth of money supply, point
out that this deficit will become ever larger, because of cumulative of effect
of interest payments (David 1992: 204). This idea is supported by Liviatan and
Piterman (1986: 324) «The most commonly cause of inflation is the
government budgets deficit» according to this explanation, the government
prints money to finance the deficit, and as long as the demand for money is
less that unit elastic, a larger real deficit will result a higher inflation
rate.
The more sophisticated view was expounded by Irving Fisher
(1926:785-792): When the dollar is losing value, or in other words when the
price level is rising, a businessman finds his receipts rising as fast, on the
average, as this general rise of prices, but not his expenses, because his
expenses consist, to a large extent, of things which are contractually fixed. .
. . Employment is then stimulated for a time at least.
Coe and McDermott (1977) in a study of 13 Asian economies,
highlights the fact that: just as in industrialized countries, inflation in
developing countries indicates an overheated economy and is influenced by a
variable of activity. The output gap and a measure of activity level in the
world are the sources that are suggested by this category.
According to Henry Hazlitt (1978:92) for many years it has
been popularly assumed that inflation increases employment. This belief has
rested on both naive and sophisticated grounds. The naive belief goes like
this: When more money is printed, people have more "purchasing power"; they buy
more goods, and employers take on more workers to make more goods.
Another reason of the persistent causes of inflation revealed
by Henry Hazlitt (1978:118) is the perennial demand for cheap money. The
chronic complaint of businessmen, and still more of politicians, is that
interest rates are too high. The popular complaint is directed especially
against the rate for home mortgages.
Chopra (1985:693) expresses the idea that inflation must have
a strong autoregressive component from adjustments in relation to expected
inflation. This category indicates a source of inflation, its own past
achievements.
Empirical results regarding the inflationary effect of
official exchange rate depreciation in cross-country and individual country
studies are also conflicting. For example, Canetti and Greene (1992:37),
studying a number of African countries, report a failure in their attempt to
identify which between exchange rate depreciation and monetary growth is a more
important cause of inflation.
Chhibber and Shaffik (1992:107) do not find a direct
relationship between official exchange rate changes and inflation in Ghana.
According to them, official devaluations had a positive effect on the budget
and were therefore anti inflationary. Their study found that the parallel
market exchange rate had a stronger influence on inflation compared with the
official exchange rate. However, Sowa and Kwakye (1993:50) claim that Chhibber
and Shafik (1992) emphasize monetary factors at the expense of supply factors
in Ghana and conclude that the supply constraint (output) was the main force
behind inflation.
Hyuha (1992:73) found that the devaluations of the official
exchange rate had a push on domestic prices in Uganda. The parallel rate was
also a significant determinant of inflation. Kasekende and Ssemogerere (1994:
62) reached a similar conclusion for the period 1987-1992, using monthly
data.
Ball and Mankiw (1995: 161) examines another source of
inflation, focusing on the supply of goods and services and the «cost
shock» that is to say, the movement of prices specific price level. To
capture the cost shocks, this category indicates changes in the prices index
for petroleum and petroleum product not as source of inflation.
Tsalinski and Kyle (2000: 39) analyzed the determinants of
Bulgarian inflation in the period from 1991 to 2000 using monthly data.
Bulgarian inflation has been shown to have experienced two radically different
regimes over the past decade. The dividing point between the two regimes is the
spring of 1997 when the hyperinflationary trend of the prior period was ended
by the institution of a currency board. They found that inflation during the
previous period had been determined in large part by monetary growth and to
some extent by past inflation. Inflation after the currency board was
established was no longer dependent upon monetary growth.
Ghavam Masoodi and Tashkini (2005:42), to investigate the long
term relationship between the inflation rate and its effective factors in Iran,
they used the ARDL method. The results obtained via this research showed that
GDP, the imported goods price index, liquidity and the exchange rate are the
most significant factors contributing to inflation in Iran.
According to Ferdinand GAKUBA (2009: 30) Inflation is thought
to be an outcome of various economic factors. In Rwanda context he choice the
factors from supply side that come from cost-push or mark up relationships
characterized by unit labor cost , import prices and oil prices index in the
long-run; the demand side factors that may cause the demand pull inflation;
monetary factors; and foreign factors. In order to capture the various
determinants of inflation he has combine the methodology developed in Brouwer
and Neil R. Ericsson (1998) and Juselius (1992) for Australia inflation.
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