The Relationship between Gross Fixed Capital Formation, Inflation and Economic Growth in Uganda (1998-2016)

Abstract

This study investigated the relationship between gross fixed capital formation, inflation and economic growth in Uganda using quarterly data for the period 1998 to 2016. Specifically, the study: examined causality between economic growth (RGDP), inflation (INFGR) and gross fixed capital formation (GFCF) and examined the forward and backward interactions between gross fixed capital formation, inflation and economic growth. Given the likely simultaneity between gross fixed capital formation and economic growth, two-stage least squares (2SLS) method of estimation was used to tackle the problem of endogeneity and Granger (1987) was applied to test for causality between the variables. The Granger-causality test revealed that real GDP does not granger-cause gross fixed capital formation. On the other hand, there was no causality between inflation growth rate and economic growth as well as between inflation and gross fixed capital formation for the period 1998 to 2016. The study subjected the simultaneous equations to a chow break test and only the gross fixed capital formation model showed existence of a structural break resulting from differentials in both the intercepts and slopes. Therefore the study adopted a separate regression model for the gross fixed capital formation model. The empirical results show that gross fixed capital formation and inflation significantly affect economic growth positively (0.708) and negatively (0.021) at 5 percent level of significance. Furthermore, the coefficients of Household/NPISHs final consumption expenditure along with Net exports had significant positive effects (1.31and 0.944) at 5 percent. Conversely the ratios of development government expenditure had a significant negative (0.332) effect on economic growth. In other models, inflation had an insignificant negative (0.019) effect on gross fixed capital formation while real GDP had a positive (8.614) insignificant effect on inflation at 5 percent level in the long run. 2SLS regression also showed that, the effect of inflation on Gross fixed capital formation does not show a similar pattern to that of inflation and economic growth. The study recommends that government should enforce policies that enhance increased export production and savings in order to speed up the process of capital accumulation and economic growth. This can be done through promoting an industry-led growth sector economy that will create more savings, capital investment and consequently economic growth.