Inflation and economic growth; An empirical analysis of Uganda

Abstract

In this paper, an examination of the relationship between and economic growth in Uganda over the period of 1990-2015 by using time series data is performed. The study employed the vector error correction model (VECM) and the Ordinary Least Square (OLS) model.

An evaluation of the trend of GDP growth rate and inflation showed an inverse volatile relationship between the variable shown by the rate at which they are fluctuating. The results reveal that, inflation (INF) and interest rate (RIR) have a negative impact on economic growth (GDP ) while foreign direct Investment (FDI) and Trade all have appositive impact on Economic Growth (GDP).

The Vector Error Correction and the Ordinary Least Square models show the existence of a negative significant relationship between inflation and economic growth in Uganda both in the short and long run. This implies that, a high level of inflation is harmful for the country meaning that inflation does not stimulate economic growth in Uganda.

Therefore, co-ordination between macro-economic policy makers is vital and should have to raise their hands and put their eyes on measures that put down inflation in order to have sustainable economic growth in the country. These include;- The negative significant effect of inflation on growth imply that policy should put more focus on interest rate however other variable like Foreign Direct Investment (FDI) and trade that have a positive impact on economic growth should be given attention to. This will help to deal with other structural bottlenecks affecting growth as well.

The inverse relationship between interest rate and economic growth calls for a need for the Government to focus on ways of reducing the high interest rates charged on borrowing by the commercial banks that have discouraged borrowing and the low interest rate on savings has discouraged savings as well.

Since Foreign Direct investment (FDI) and Trade have positive impact on economic Growth the Government should encourage FDI’s that enhance economic growth and should aim at increasing trade especially exports which enhance production and investment in terms of expansion to meet the growing foreign demand hence increasing economic growth. The monetary and fiscal authorities should do all in their abilities to ensure that they come up with sound policies that will help curb any spiraling inflation and uphold the highest degree of confidence within the investing community if it’s to enhance growth.

In general, it can be concluded that, growth in Uganda is affected by both inflation and other macro – economic variables. The above finding is almost less in line with the Keynesian and the Neo-Keynesian theoretical framework. Keywords: inflation, economic growth, vector error correction model and least square model.