Abstract
Since the Egyptian economy has recently moved towards inflation targeting, it became very important to know whether exchange rate movements have serious inflationary implications or not. To investigate this subject, the study aims to analyse the relevance of inflation with the exchange rate by using the Granger-causality test. Two indicators of inflation will be used, the consumer price index (CPI) and wholesale price index (WPI). In general, the results show a strong relationship between the two variables in a way that may give support to the application of ‘flexible inflation targeting regime instead of strict inflation targeting regime’.
Highlights
Egypt has recently decided to adopt price stability as an explicit monetary policy objective
The analysis in this paper was based on the Granger-causality test for monthly data during the period of 1990-2008. It showed a strong relationship between exchange rate changes and inflation
Both indicators of inflation succeeded in reflecting a clear exchange rate pass through (ERPT) phenomenon, but wholesale price index (WPI) showed a faster response to exchange rate changes than consumer price index (CPI)
Summary
Egypt has recently decided to adopt price stability as an explicit monetary policy objective. Since June 2005, the Central Bank of Egypt has taken several steps to develop its monetary policy framework with the intention to implement an inflation targeting regime in the medium term (Al-Mashat, 2008). The transition to this regime was justified by the negative effects of exchange rate targeting and the successful experience that many emerging countries had achieved through the application of an inflation targeting regime since 1990s.Under this regime, the exchange rate fluctuations have become an important issue in economic policy debate. The high ERPT is a point of concern for developing countries which consider adopting an inflation targeting regime This is due to the risk of seeing the exchange rate becoming the main objective of the central bank, dominating the supposed primary objective of the monetary authorities, which is the inflation rate (Youssef, 2007).
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