On the Sources of Inflation in Kenya

The authors develop a semi-structural, New Keynesian open-economy model with separate food and non-food inflation dynamics to study the sources of inflation in Kenya in recent years. They filter international and Kenyan data through the model 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. The filtration exercise helps 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. The authors 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.