Trade Openness and Crude Oil Price Effects on Food Inflation: Examining the Romer Hypothesis in Kenya

Caspah Lidiema

doi:10.11648/j.jwer.20200902.12

Abstract

Food Prices accounts for about 36% of the overall consumer price index in Kenya and it’s the single largest of the 12 components that make up the index. Therefore, shocks in food prices could considerably be transmitted to the overall consumer price index. While Kenya agricultural production is heavily rain-fed, external pressures from and shocks from crude oil price, international trade are transmitted inwards and pile more pressure on food prices as well. While inflation tend to follow all the available information in the market and business per the rational expectations’ theory, price factors are a key determinant of business cycles, because price stickiness tend to drive demand. Therefore, demand for food products could be driven by several market features including internal food prices, oil prices, productions and importation costs. The objective of this research was to analyze the effect of Trade openness on food inflation in Kenya with a view of establishing if Romer’s hypothesis holds in Kenya. The second objective is to establish the effect of crude oil prices on food inflation in Kenya. The study employed Autoregressive Distributed Lag (ARDL) cointegrating technique to estimate both short-run and long run estimates. The study findings indicate that trade openness significantly has a reducing influence on food inflation hence confirming the existence of Romer’s hypothesis in Kenya. Secondly, crude oil prices have a positive and significant effect on food inflation. Interestingly, the study found that money supply does not have significant influence on food inflation. The study recommends embracing and adopting international free trade agreements to further leverage on imports prices, increase buffer storage to cushion against food demand and hence stabilize food prices. Secondly the government should enhance further price controls on oil prices to reduce spillovers to food production and supply costs. In addition, Kenya should develop technologies to improve agricultural farm production to leverage dependence of rain-fed agricultural sector.

Highlights

The results reveal that the null hypothesis of unit root is rejected at the level form for Trade Openness (TO)
All other variables food inflation CPIF, Money supply (M2) and Foreign Exchange (FX), the null hypothesis cannot be rejected at level form
All variables are either integrated at I (O) and I (1) and all variables meet the conditions that allows the use of Autoregressive Distributed Lag (ARDL) model as suggested by [34]

Summary

Introduction

Most emerging economies suffer economically due to high inflation levels. In Kenya for instance, inflation rose to up to 20% in 2012 mostly spearheaded by political temperatures and uncertainty. In addition to changes in macroeconomic policies, inflation is caused by several factors including, increase in income level and money supply; oil prices both at domestic and global level; higher demand domestic good, and sharp rise in international commodities [1, 2]. Food inflation tend to be high and very volatile than Non-Food inflation especially in the emerging and lowincome economies [3]. In Kenya for instance, food inflation is about 36% of the total inflation [4]

Objectives

Results

Conclusion