EFFECTS OF INFLATION AND UNEMPLOYMENT ON ECONOMIC GROWTH IN KENYA - 1995 TO 2004.

BY KHAGGAYI RONALD INGALA ECO/010/01

SUPERVISOR DR. P.L. ONSANDO

ECO 420: RESEARCH PAPER

DEPARTMENT OF ECONOMICS AND AGRICULTURAL RESOURCE MANAGEMENT SCHOOL OF BUSINESS AND ECONOMICS MOI UNIVERSITY P.O. BOX 3900 ELDORET.

A RESEARCH PAPER IN PARTIAL FULFILLMENT FOR THE AWARD OF BACHELOR OF ARTS DEGREE IN ECONOMICS.

© AUGUST 2005

DECLARATION I declare that this is my original work, and it has not been submitted to any other institution of higher learning.

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This research dissertation has been submitted for examination with my approval as the university supervisor.

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DEDICATION This dissertation is dedicated to them who, When there was darkness you held the candle for me to see, In the rain you held my hand not to fall, When I was lonely you held me close. Walking with me along the way, a journey that had ups and down, My success is your success.

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ACKNOWLEDGEMENT The journey has been tough, from commencement to completion of this study; I received tremendous help, cooperation, support and encouragement from different authorities, friends and family. First of all, I express my deepest sense of gratitude to the authorities of Moi University who kindly admitted me as an undergraduate student and permitted me do this study for the award of a Bachelor of Arts degree in Economics. I express my indebtness to my supervisor, Dr. P.L. Onsando under whose guidance I was able to complete this research To the Economics department lecturers who have imparted in me the knowledge that I have. Special thanks to Dr. M.M.M. Kadenyi, a mother, true friend and mentor who was there when I was about to give up. Thank you for you great assistance, it is much less than you deserve. I would also like to record my appreciation to Rono who assisted me in typing this manuscript. Friends like Sawe, Njuga, Sammy, Njiriri and many others who gave me hope when there was none. Last but not least to my family for their tireless efforts towards ensuring my academic success. Their support financially, socially and emotionally was always there for me. While expressing my deepest sense of gratitude, words elude me to express my indedtness to them. This is all for you. It will not be an exaggeration to say that by thanking them am thanking myself. To God is the glory for seeing me through the period of study.

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The research is an investigation into the effect of inflation and unemployment on economic growth over the period.ABSTRACT GDP is a measure of aggregate activity hence an important macro-economic variable. the economy has shown mixed signals (no general trend of increase in growth or decrease). inflation and unemployment. unemployment and inflation tells us about other important aspects of how an economy is performing. The government should come up with the necessary policies to counter the negative effects of unemployment and inflation on economic growth. Unemployment rates in Kenya have remained relatively high. This is also the case for inflation where in one period there is high inflation followed by a period of low inflation. There are positive signs of economic growth while unemployment rate is decreasing with lower levels expected in future. In addition it is often associated with social consequences and affects the welfare of the unemployed. The findings of this paper indicate that there is a negative relationship between economic growth. Inflation affects a country’s growth. But. Unemployment rate is the ratio of the number of people who are unemployed to the number of people in the labour force. Why care about unemployment? It is an indication of whether the economy is operating above or below its normal level of activity. which may slow the rising trends of the economy. Inflation will determine the general price level in the economy and therefore of much importance to both producers and consumers. two other variables. iv . Over the period between 1995 and 2004.

2.1.1. Unemployment and Economic Growth over the Period 4. Statement of Hypothesis 1. Data Collection 3. Specific Objectives 1. Conclusion 5.4. FINDINGS. RESEARCH METHODOLOGY 3.2. Justification of the Study CHAPTER TWO 2.4.1. Data Presentation and Analysis 3.4.0. Trend Analysis CHAPTER FIVE 5. INTRODUCTION 1.0.3. Secondary Data 3.0.0. Recommendations Limitations of the Study REFERENCES i ii iii iv vi vii 1 1 1 2 3 3 3 4 4 6 6 11 11 11 11 12 12 12 12 14 14 14 16 18 21 21 21 22 23 24 25 26 26 33 APPENDICES APPENDIX I APPENDIX II v .3.3. Findings 5.2. Statement of Objectives 1. LITERATURE REVIEW CHAPTER THREE 3.2. Broad Objective 1.3. CONCLUSION AND RECOMMENDATIONS 5. DATA ANALYSIS 4.1. Conceptual Framework CHAPTER FOUR 4.3.TABLE OF CONTENTS Declaration Dedication Acknowledgement Abstract List of acronyms List of figures CHAPTER ONE 1.1.0.0.5.0.2. Inflation.0.1.2.1.1.3. Background of the Problem 1. Sampling Design 3. Statement of the Problem 1.2. Research Design 3. The Regression Model 4.

LIST OF ACRONYMS CBS – Central Bureau of Statistics CBK – Central Bank of Kenya KDHS – Kenya Domestic and Household Survey GDP – Gross Domestic Product GNP – Gross National Product vi .

1. Summary of Inflation rate. 1998 – June 2004 15 16 16 18 20 20 33 vii . Mean of the Variables Table 4.3. Unemployment rate and the Real GDP growth rate between 1995 and 2004 in Kenya Table 4. b1 and b2. Unemployment and GDP growth versus Time Graph 2: Inflation Rate and GDP growth Rate Graph 2: Unemployment Rate and GDP growth Rate Chart 1: Real GDP rates. Estimates b0.LIST OF FIGURES Table 4.2. Graph 1: Inflation.

Government might very well and often do increase the money supply continuously. The budget was presented as a poor man’s budget.0. The unemployment rate is the percentage of the labour force that is without employment. Inflation may be caused by a continuous increase in the supply of money. supplied exceeding the quantity demanded for labour at the going wage rate. Background of the Problem The recently presented Kenyan budget did not state the rate of monetary expansion to be targeted.6%. With reported growth in the economy in the year ended July 2004 to June 2005. which is unemployment that occurs because individuals choose not to accept available jobs at the current wage rate. Even so. and involuntary unemployment. Inflation is a continuous increase in the price level. and so the price level typically grows more slowly than the money supply. the Kenyan economy grew by 4. If the demand for money were fixed. This tempers the inflationary effect of money supply growth. The monetary expansion rate determines the inflation rate in a country. Unemployment can mainly be classified as voluntary unemployment. a higher rate of money supply growth is expected to cause a higher rate of inflation. Rising real incomes usually cause the demand for money to rise over time. or a combination of the two. The term unemployment does not necessarily mean the number of people who are without employment. then the price level would grow at the same rate as money supply. 1 . a continuous decrease in the demand for money.CHAPTER ONE 1. however. INTRODUCTION 1. inflation ends up hurting the poor most in present day Kenya and they too feel the pinch of unemployment.1. which is as a result of the quantity of labour. sustained over a period of time.

an increase in prices may reflect an increase in output. but ignored in major reporting of the economic growth. Inflation and unemployment are normally referred to as the twin evils and have detriments to the economy. Full employment is achieved when everyone who is willing to work and is able to work has a job.10. Economic growth has been pegged to the GDP measure. Cyclical unemployment is more common which arises from the business cycle.Unemployment can be further divided into cyclical unemployment.2. National income accounts are a measure of output in terms of prices. For example. 2 . most economists do not account for the effects of inflation and unemployment on the overall performance of the economy. Inflation is computed separately mainly through the consumer Price Index (CPI) and the GNP-deflator. This state of economy is hard to achieve. In determining the market prices. will this increase be due to economic growth especially in the manufacturing sector or will it be attributed to inflation? Thus. frictional unemployment. which will be reflected in the increased GDP amount holding inflation constant which in not the case. Statement of the Problem In the calculation of GDP. National income accounts do not factor in the effect of inflation on the prices of goods and services. 1. if the cost for a packet of Unga between the year 2003 and 2004 rose by Kshs. Serious unemployment must be avoided because of its economic consequences for the total economy and the hardships it brings to individuals and families. a measure of output to evaluate the state of the economy. structural unemployment and seasonal unemployment.

1.3. However.3. Broad Objective • To understand and explain the factors that contribute to the behaviour of the economic growth model of Kenya from 1995 to the year 2004 and study the effects of inflation and unemployment on the Kenyan economy. Statement of Objectives 1.Employment contributes towards the overall calculation of the GDP in terms of wages and in some cases man-hours used in production processes. The unemployment ratio is mainly used to describe the hardships of the people who are willing to work and are actually striving to do so.3.2.1. • To study and explain unemployment as a hindering factor to the attainment of higher rates of growth of the economy. Specific Objectives • To study and explain how inflation affects the growth rate of the economy through its effects on the purchasing power of consumers. 1. a more comprehensive study needs to be undertaken to establish where any relationships subsists between inflation and unemployment to economic growth. Since inflation and unemployment affect the general economic behaviour. the effects of unemployment are more severe on the economy in that it reduces the amount of disposable income being held by families or households. Their effect on the economic growth model of an economy or nation is not given in clearly defined terms. 3 .

An analysis of both helps in the development of a monetary policy that will assist in achieving a positive growth in the economy. they affect the majority of the population. 1. their direct relationship or effects on economic growth have been ignored. Inflation and unemployment cannot be cured simply by accelerating growth. Unemployment is chronic and intractable in nearly every developing country. Unemployment rates in Kenya have held the two-digit percentage over the period under study (1990-2004). Statement of Hypothesis • High rate of inflation and unemployment leads to a low growth rate of the economy. Justification of the Study Inflation and unemployment are referred to as the two evils of the economy. 4 .• To analyze and determine the relationship between inflation. • Increase in the rate of inflation and unemployment rate corresponds to an increase in the economic growth rate. The relationship between inflation and unemployment affect the other and hence. • High rates of economic growth are not as a result of low levels of inflation and unemployment. More so. 1. Though not tangible.5. Its effects are felt directly by all persons ranging from the rich and more so among the poor of the population. it is only proper to consider their total effects on the economic growth of a country.4. unemployment and economic growth in the period from 1990 to 2004.

which may further lead to low savings and investment levels. it will be a precursor to multiple economic problems.As long as unemployment and inflation exists. 5 . High levels leads to low incomes. For example. increased inflation rates lead to a reduction in the purchasing power of households hence a reduction in aggregate demand. This study aims at helping understand and find solutions to the twin problems of inflation and unemployment and their effect on economic growth.

it is not part of the national income accounts at all.CHAPTER TWO 2. The trend of inflation and unemployment in an economy will determine future macroeconomic policies to be undertaken in an economy. people think about the future. Unemployment. in the computation of national income mainly given in terms of output (GNP does not consider inflation and unemployment). Hall and John B. 6 . Macroeconomics: Theory. “When making decisions. Both inflation and unemployment are economic problems that affect the trend of economic activities.478. in making future decisions. LITERATURE REVIEW National income accounts and other related accounts do not cover all of the important measures of economic performance. but they have formed the basis of most policy initiative of many past years.”1 Economic fluctuations like inflation and unemployment are recurrent from one business cycle to another and hence need to be considered in dealing with overall economic performance of Kenya. [Robert E. Hall and John B. 1 Robert E. Thus. pg. and their expectations of the future can be modeled by assuming that they have a sense of economic fluctuations and use their information to make unbiased (but not error-free) forecasts. though it is closely related to most components of the national income accounts like consumption levels. Inflation and unemployment are not only more visible to unsophiscated observers.0. as is expressed that. The above sentiments further highlight the point that. the information available should be abit error-free. Taylor]. Performance and Policy. Inflation is measured by a price index that is not part of the accounts. Taylor. ignorant of the fact that they affect the whole economy both directly and indirectly. while it is possibly a most important dimension of performance.

and rises if unemployment falls below normal levels. when inflation is high.2 Inflation is not an increase in all prices. currency and non-interest-bearing checking accounts are undesirable because they are constantly declining in purchasing power. when inflation rages. Secondly. When inflation hits. and disinflation is a reduction in the rate of inflation. The rate of inflation is the percentage change in the average price of all goods in the economy. First. the economy is better 2 Gary W. This means that. though not reflected in the overall GNP figure annually and hence avoided in deciding the level of economic growth. there are tax distortions. Inflation is defined as a time of generally rising prices for goods and factors of production. In any economy inflation is undesirable. Inflation is measured as a rate of change in price index from one period to the next. This is because of the specific economic costs associated with inflation. the actual value of these deductions are much less than it should actually be. Yohe.Macro policy makers try to achieve the best combination of employment and inflation for an economy. it is instead. inflation and unemployment are still considered by macro policy makers as vital and important in any economy. Since labour supply is inelastic. for example. Deflation is exactly the opposite. There are also unfair gains and losses. an increase in the general level of price and costs. 7 . the marginal value of time in other uses falls if unemployment rises. Study Guide to Accompany Samuelson-Nordhaus Macroeconomics. To them. People see inflation as a breakdown of the basic government responsibility to provide a stable unit of purchasing power. some people gain and some lose for example people whose pensions are fixed in shilling terms lose. Therefore. The marginal social cost of unemployment is higher when unemployment is high. higher prices represent diminished real income. Some people may not understand the relation between their own incomes and rising prices.

as against fluctuating output and employment. unemployment is one of those topics that bring dismal science out of the tower of numbers and make it a social science. it misses the human cost: the cost of repairs when homes are broken by the unemployed people. To him. It is a shorthand formula that closely approximates the cyclical relationship between unemployment and real GNP. 8 . Economists are quick to recall Okun’s Law when they are asked to evaluate the economic cost of unemployment. pg.60. Studies that have been made on inflation and unemployment on the same analysis mainly centre on the trade-off between inflation and unemployment giving the Phillips-curve 3 Robert E. Okun’s Law says that. Hoye (Ibid) notes.off with stable output at optimal employment level. This is to mean. [Robert E. Economists are quick to recall Okun’s Law when they are asked to evaluate the economic costs of unemployment. for each percentage point by which the unemployment rate is above the natural rate. The slope of the relationship is roughly 3 percentage points of real GNP for each percent of unemployment. Hall and John B. Taylor. Nonetheless. These loses are astronomical when they are compared with the efficiency costs of monopoly and other forms of imperfect competition. anguish of workers in thousands who show up to any interview among others.3 Gary W. The percentage of GNP from potential is called the GNP gap. the costs of strict environmental controls or even the estimate waste in government spending. Hall and John B. Taylor]. real GNP is 3 percent below potential GNP. The movement in unemployment is closely related to the movement in the percentage departures of real GNP from potential GNP. even the unemployment figures have shortcomings in themselves and hence their full impact on the economy cannot be fully comprehended.

The Phillips-curve analysis however will hold only when unemployment is below the natural rate. Modern theory suggests that there is no trade-off between inflation and unemployment in the long-run.4 There are various types of inflation. which push aggregate supply up. unemployment rates lower than the natural rate are associated with inflation above the inertial rate. 9 .] 4 5 Ibid.175. it is therefore associated with lower levels of real GNP. Ibid. Demand-pull inflation is the result of excessive aggregate demand and can be associated with higher levels of real as well as nominal GNP. [Central Bank of Kenya. the long-run Phillips curve is therefore vertical at the natural rate of unemployment. which is hard to achieve by many countries especially in LDCs and developing countries. nominal GNP can be higher or lower. It is not easy to measure the precise amount of impact of or arising from higher inflation experienced among population in their respective income groups. At the natural rate of unemployment and the inertial rate of inflation in short and long-run curves. Individuals expect it. pg. and expectations tend to become self-fulfilling prophecies. Higher inflation stems from higher prices of goods and services consumed across the economy. Cost-push inflation is caused by increased costs.181.5 No economy has yet managed to maintain full employment over long periods of time with stable prices and free markets. pg.analysis. Inertial inflation therefore reflects an internal rate of inflation with which an economy seems to be comfortable. Kenya included. Inertial inflation is expected and sustained because it is built into contracts and other financial agreements.

Economic Survey 2005. the Kenyan economy has recorded a positive growth of 4.The Kenyan overall inflation in the month of May 2005. development in food prices. 10 .7 The relationship between inflation. lagged effects of monetary expansion and high increases in wages. development in energy costs. unemployment and economic growth though not directly can be put in economic terms. May 2005. High levels of inflation and high levels of unemployment lead to a situation of stagflation.6% of GNP. which include. overall inflation has been on a rising trend due to several factors. More so.6 Similarly. 6 7 CBK Monthly Review. the unemployment levels have been on the rise.

The period between 1995 and 2004 is representative enough in analyzing the relationship that is present between the variables (inflation. To give a nationwide outlook. The data is used to develop. unemployment and economic growth. the implicit price deflator is used. 11 . The annual inflation rate is generated by the Central Bank of Kenya and published in its Annual Report of 2004.CHAPTER THREE 3. Sampling Design A 10-year period between 1995 and 2004 was selected on which the research was based. a regression model is designed is designed from secondary data giving annual figures of the dependent and independent variables in the model. RESEARCH METHODOLOGY 3. Research Design This research seeks to explain a casual relationship between inflation. In the development of the research. unemployment and economic growth). unemployment and the rate of economic growth in Kenya. and prove the reliability of the model hence assist in the explanation of the relationship between inflation. Economic growth rate is as presented in the Kenya Economic Survey by the Central Bureau of Statistics. Statistical Abstract 2004. 3.0.1.2. a stagnant period between 1997 8 CBS. The unemployment rate is generated from employment figures in the Annual Statistical Abstract8 by the Central Bureau of Statistics and the working population figures from the Kenya Domestic and Household Survey by the Central Bureau of Statistics in 2004. The period between 1995 and 2004 to consist of sample data has undergone several phases like economic recovery just after the 1992 general elections.

Data was collected from publications like: − The Economic Survey 2005 − The Statistical Abstract 2004 − The CBK Annual Report 2004 − The CBK Monthly Review for May 2005. and a recession period. 3.and 1999. Y = b0 + b1 X 1 + b2 X 2 + u Where. Y is the economic growth rate X1 is the inflation rate 12 . Conceptual Framework This research set out to investigate the effect of inflation and unemployment on economic growth in Kenya. which was heavily felt in 2000. Data Collection 3.3. The economy has been on a recovery path from the year 2002 onwards. The model is given as.1.1. This relationship is designed on a multiple regression model assuming a linear relationship between the variables. Secondary Data Data collected for the research was from secondary sources mainly found in official government publications and other government departments like the Central Bank of Kenya.4. Data Presentation and Analysis 3. 3.4.3. Secondary data was useful in building the regression model and conducting tests thereon.

13 . b1. It is assumed that the random variable U has a normal distribution with zero mean. The student t-test is conducted on the variables to determine the significance of the variables in the model.X2 is the unemployment rate b0. Ε u) =0 ( This reduces the estimation model to. b3 are constant coefficients. Y = b0 + b1 X 1 + b2 X 2 The significance of the model was determined by testing for the variation in Y as explained by X1 and X2 using the R2.

0.3% in 2004. This is the highest growth recorded over the period. 14 . However.5% and this may be attributed to being a period when general elections were being held. The unemployment level in Kenya has been very high.CHAPTER FOUR 4. Nearly half the Kenyan population is unemployed.6% respectively. Inflation. Between 1995 and 1996. A portion of self-employed persons and family workers who do not receive regular wages are excluded. Also excluded are employment from informal sector. then the government was focusing more on re-election into office rather than economic prosperity. unemployment was higher between 1997 and 2002 but the unemployment was higher between 1997 and 2002. in the year 1997. the growth rate of the economy did not show a steady or regular pattern. This may be attributed to the various policies initiated by the new NARC government which came into power on a platform of creating employment opportunities – ‘500000 job opportunities per year’ – and focusing on economic growth. the rate of economic growth in real GDP was 4. directors and partners serving on a regular basic salary contract.8% and 4.1.2% but rose in following years to 4. Unemployment and Economic Growth over the Period Over the 10-year period from 1995 to 2004. 9 The employment figures in the Statistical Abstract published by the CBS include casual workers. In the year 1995 and 1996.0. part-time workers. The inflation rate has generally been maintained at one figure level. Still unemployment levels are still high with structural unemployment being rampant in Kenya as people become desperate for employment.0. The lowest level of economic growth to be achieved in Kenya economy was in the year 2000 with a real GDP growth rate of 0. but began falling in the years 2003 and 2004. DATA ANALYSIS 4. part-time employees.9 The available statistics show that. the growth rate went to dismal levels of 0. the government was able to confine underlying inflation within the single digit range. This was mainly due to tight monetary policy introduction by the Central bank of Kenya. rural small-scale agriculture and pastoralists activities.

8 2004 11. reason being that it was period when general elections were held in Kenya. Economic Survey 2005 and CBK Annual Report 2004. For example. there were cases of bribery and excess circulation of liquid money in the country.8 50. In the year 2001.4 4.4 1. World Hope organization closed its HQs in Kenya and relocated to Tanzania citing high costs of operation. Unemployment rate and the Real GDP growth rate between 1995 and 2004 in Kenya.3 0.3 4.2 2003 09. inflation shot up to 11. Real GDP growth. Higher inflation is also seen in the year 2000 and in the year 2004. Table 4. 2.2 2001 05. Statistical Abstract 2004 and The KDHS Survey 2004. Interest Rate Unemployment Real GDP growth (%) (%) rate10 (%) 1995 01.3 2000 10.9 51.6 44.3 1999 05.1 2.8 0.6 4.1. due to political uncertainty.2 49. coupled with lack of opportunities for employment. mainly being as a result of increasing commodity prices as influenced by rising world oil prices.8 1996 08. in 1997. Unemployment Rates.3 1.8 51.6 1997 11. investment level was very low.7 3. 3. CBK Annual Report 2004.3 Source: 1.9 48.However. 15 .8 45.0 49. 10 See footnote 11.6 4.4 2002 04. In addition.9%. Inflation Rates. Summary of Inflation rate.7 50. investments were low and many companies were closing down moving out of the country and relocating to other areas with cheap operating costs.6 47.5 1998 06. Year High rates of unemployment over the period may be attributed to a previous high population growth rate.

4218 2.8836 2.2 4.03 1.8649 3.1.7035 -18.8865 -7.962 yx2 -2.1 49.6129 18. b0= -8.2 1.2822 -2.6 48.37 -1.4 45.8052 -6.8 10 5.86 -2.4336 28.7556 2.56 x1 -6.6 8.0198 -3.75 0.8 11.1932 -18.3489 5.97 x2 -1.5625 0.0398 6.413 4.2436 3.6169 3.55 -3.3.44 -2.6 49.83 2.6 49.6025 20.5715 10.55 -4.4 1.7649 4.7609 101.9025 7.2025 6.3 50.4 51.3 Unemployment Rate x1 47.7025 54.3 Note: All values are in percentage Table 4.4516 2.3 27.488 1.3609 1.2875 2.2.7 5.54 -0.036 -0.847 3.015 From the calculations11 the estimates are.3136 0.4 ∑X2 = 488.95 2. Estimates b0. The Regression Model Table 4.8 4. the true regression model is given by.8 51.4 1.93 -1.17 3.1936 6.621 x22 1.83 -3.66 -1.0325 -1.2 9.0025 3.7205 -2.4596 5.5 3.87 x1x2 7.7 50.7 50.3 44.2.0176 0.8 51.3622 -9.06 1.3 50.27 -0.9 6.8 4.43 2.3 488.6 76.54 1. Y ∑ ∑X1 = 27.3 0.0635 -17.3 0.837 -5.85 1.94 1.7 5.825 yx1 -12.232 b2= -0.4 y 2.575 -0.3 2.4225 1.6 Unemployment Rate X2 47.8 4.56 -0.5 Year 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Total Interest Rate y 1.5 3.3716 0. Y=-8.7089 15.4615 -1.27X2 11 See Appendix 16 .9 6.2329 0.3 Inflation Rate X1 1.68 b1= -0.55 -2.8 11.25 -0.3 44.5375 -0.3 =76. b1 and b2.3025 12.8 4.8 4.5 Real GDP Growth X2 4.2515 -5.55 y2 4.4 51.6 0.24 0.2 4.6 8.68-0.5648 -0.45 2.25 0.2 1.2 9.4.0378 5.5625 0.6 48.232X1-0.9 11.3 2.1 49.8 4.565 -0.5625 0.27 4.098 -10.6 0.3489 11.5208 0. Mean of the Variables n 1 2 3 4 5 6 7 8 9 10 Real GDP growth Y 4.124 x12 36.8 10 5.9 11.27 Therefore.45 1.337 -7.4 45.

This means the t-test shows there is casual relationship between inflation rate.025.96<tc<1.607 respectively. that is.751. –t0. 1. Testing the Significance of the Model12 From the student t-test. they all fall in the critical region with the value of –0. the real GDP growth rate.This true regression model shows both inflation and unemployment have an indirect relationship with the real growth of the economy.96 For b0. unemployment rate and new real GDP growth.2.e.2 Trend Analysis 12 See Appendix 17 . With the tc falling in the acceptance region i. we accept the null hypothesis and conclude that the variables are not significant in explaining the model. b1 and b2.013 and 1. 4. -1.025<tc<t0. This means that an increase in inflation and unemployment will lead to a decrease in the level of economic growth.

REAL GDP GROWTH (%) 60 50 40 30 20 10 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 UNEMPLOYMENT INFLATIO N REAL GDP GROWT 2004 YEARS Over the period [1995-2004]. Inflation has also remained at higher levels than real GDP growth.GRAPH 1: INFLATION. 18 . unemployment rates have remained at high levels. Between 1997 and 2003. In addition. Since 2002 to 2004. unemployment rates remained stable at high levels. Overall inflation has been on a rising trend since the year 2000. The rising trend in overall inflation is due to the following: • Developments in food prices: delayed rains in the 2000 and 2001 put pressure on the prices of basic foodstuffs such as vegetables and fruits thereby pushing up the food basket prices. The rates of unemployment however began to fall from the year 2003 to lower levels in 2004. UNEMPLOYMENT AND GDP GROWTH VERSUS TIME 70 INFLATION . Inflation was high in 1997 and in 2000 and lowest in the year 2002. the recent sugar shortage contributed to the inflationary pressures through increases in sugar prices. inflation has been on the rise with higher levels projected in 2005. UNEMPLOYMENT.

This is seen if each variable is plotted against GDP growth rate. Demand pressures arising from huge increases in wages. the police. thereby resulting in higher pump-fuel prices in the domestic economy. unemployment rate and real GDP growth rate is not a linear one. • • The lagged effects of monetary expansion.2 % . the Judiciary and other government officers). the points are scattered on the grid as shown in the graphs below. The high oil prices also imply higher transport costs and higher costs for commodities whose production uses oil as an input. Real GDP growth at low levels over the period with the lowest level in 200 at 0. members of parliament. This is observed between the years 2002 to 2004. From the year 2002 to 2004. nurses. There is no linear relationship that can be easily denoted or graphed out of the data collected. This shows that. in the range of US$ 55-60 per barrel in the international market. GDP growth in increasing with a higher level of expected in the year 2005.• Developments in energy costs: oil prices have remained consistently high. An increase in real GDP growth rate is accompanied by an increase in inflation rate. especially in the public sector (teachers. the relationship that is between inflation rate. 19 .

Graph 2: Inflation Rate and GDP growth Rate 14 12 Inflation (%) 10 8 6 4 2 0 0 1 2 3 GDP growth (%) 4 5 6 Unemployment rate (%) and GDP growth Rate 52 Unemployment Rate (%) 51 50 49 48 47 46 45 44 43 0 1 2 3 GDP growth (% ) 4 5 6 20 .

With high levels of unemployment rate and inflation. CONCLUSION AND RECOMMENDATIONS 5. the government has not taken major steps to 21 . Findings The basic economic model for the relationship between inflation. the relationship merely holds where economic growth rate corresponds to an increase in inflation but a decrease in the unemployment rate.6 8− 0. economic growth still remains at low levels. Over the period from 1995 to the year 2004. Slight decreases are recorded between the years 2002 and 2004. Inflation and unemployment rates account for 30.4% of the changes in economic growth.0. an increase in real GDP growth rate related to an increase in inflation but during the same period there was a decrease in unemployment rate. the real casual relationship is mainly affected by the fact that. From 1996 to 1998.CHAPTER FIVE 5. FINDINGS.1. In trend analysis. Variations in unemployment remained low.2 7X 2 This basic model shows that there is an inverse relationship between inflation rate. The variables are not very significant in determining the model of economic growth. unemployment and economic growth in Kenya is given by. the rates of unemployment remained at near constant level but at very high rates. unemployment rate and real economic growth rate. Increase in the real GDP growth does not correspond to decreases in inflation and unemployment rates. from 1997 to 2002.0.2 3 2X 1 − 0. Y = − 8. Between the year 2002 and 2004. the unemployment rates remained at high levels. However.

This has the effect of a high inflation in the economy 22 . decreasing rates of unemployment are eminent but an increase in the levels of inflation. though not clearly shown. higher inflation stemmed from higher prices of goods and services consumed across the income divide. More so. as noted. changes in the crude oil prices pushers up the prices of basic commodities and services like transport.ensure a constant move in the economic growth pattern. energy and transportation goods and services at their disposal relative to residents in rural area. the effects cannot be ignored by the policy makers when coming-up with the right fiscal and monetary policy for the economy.2. Conclusion In this analysis of effects of inflation and unemployment on economic growth. However. unemployment and economic growth. a relationship still exists between the three variables. Residents in urban centers doubtlessly suffered most considering the range of fuel. This contributes to what distorts the relationship between inflation. and food items are the best examples of these commodities. Currently the economy is on a recovery model. energy. This is because. 5. Fuel. One period of economic increase may be followed by a recession and vice-versa. with prospects of increasing growth in the economy. It is not easy to measure the precise amount of impact arising from higher inflation experienced among different income groups. However. The inverse relationship however holds much ground in the Kenyan situation. This is seen between 2003 and 2004 and in the projections for the year 2005.

Research is not conclusive. inflation and economic growth.Lack of data for some of the variables like the unemployment statistics will mean that some vital element of the model are excluded which makes the model less reliable. 2. Unemployment statistics should be inclusive of all employment people. A more extensive research needs to be conducted to establish the real relationship that exists between unemployment. 23 . 5. High levels of unemployment and inflation have that economic growth rate is or remains at very low levels. the relationship may be best understood with the use of trend analysis rather than using a linear regression model. On a general level. A good working economy corresponds to low levels of unemployment and inflation. Recommendations 1. Economic theory will mainly hold in normal circumstances like the full employment level or at the natural rate of unemployment. In extreme cases mainly facing developing nations like Kenya. Data should be collected to cover all sectors of he economy. This will help in determining the real issues at hand.3. for the economy to grow. there is need for a decrease in the levels of unemployment and inflation rates. there are high levels of unemployment. In the case of Kenya. This makes it hard for economic models to hold in such cases unless coming up with a new concept. Decrease in inflation and unemployment does not necessarily mean an increase in the level of economic growth. inflation is high and fluctuating and the levels of economic growth are extremely low. and more concrete model.

the random variable u is significant. government spending. 2. Development of the Model 13 See Data presentation assumptions (Chapter 4) above. Assumptions Economic growth rate is affected by many factors. unemployment data is not inclusive of data from all sectors of the economy. Data Collection Relying on secondary data also mean that any error in the source will also be carried out in the research. Ε u) ≠ 0 ( However. In this case. errors and assumptions not disclosed in the source document will also reoccur in the research. That is. The ceteris paribus. Thus. household’s expenditure among other factors.13 Non-availability of data like the unemployment statistics means that using a combination of data like employment levels from the Statistical Abstract and working population data from the KDHS Survey 2004 compounds the problem. 24 . For example. These include foreign investment. taking only inflation rate and unemployment rate in coming up with a causal relationship leads to a weak model.Limitations of the Study 1. Salary increment without of holding employment constant will have the effect of affecting economic growth. in the model Ε u) =0 ( 3.

unemployment and economic growth have not been done on the twin effects of inflation and unemployment on economic growth. Reliability depends on the source of the data. Lack of Resources. Data collection had to be limited and verification of the collected data being near impossible.Most economic studies conducted inflation. The research attempts to come up with the model and thus a new concept in the study of economics. 4. There exists no previous model to base the study upon and hence act as a guideline to the research. Time The research was conducted over a short period of time. Lack of resources limited the researcher to use other forms of collecting data like questionnaires and interviews with people who are knowledgeable on the areas of inflation. unemployment and economic growth. 25 . 5.

b1 and b2.APPENDICES APPENDIX I Calculation of the Means Mean.3 10 = 7.4 10 2.825 ) − (17 .015 ) 2   = −1224 .87 x − 17 .621 x54 .5 10 = 48.962 x54 .63% X2 = X2 = ∑X n 2 488 .85% Calculation of the Estimates b0. Y = ∑Y n = 27 .74% Y = = ∑X n 1 76 . 2 ˆ =  (∑ y1 x1 ∑ x2 ) − (∑ y1 x2 ∑ x1 x2 )  b1   ∑ x12 ∑ x22 − (∑ x1 x2 ) 2    (−18 .54465 5281 .8611 26 .825 ) − ( −10 .015 )  =  (101 .

74 − (0.962 (101 .935 28 .27 ˆ ˆ ˆ b0 = Y − b1 X 1 + b2 X 2 = 2.124 7.334 28 .63 )) + (−0.304 =30.87 X 101 .86 Coefficient of Multiple Determinations R 2 y1 x 2 = ˆ ˆ b1 ∑x1 y1 + b2 ∑y1 x2 ∑y 2 = 4.124 ) 27 .4% Ry1 x1 = = ∑x y (∑ x ∑ y 1 2 1 1 2 1 18 .399 + 2.015 ) (101 .85 )) =-8.621 ) − (−18 .015 ) 2 −1427 .624 x 28 .2587 5281 .825 ) − (17 .124 = =0.232 2 ˆ  (∑ y1 x2 ∑ x1 ) − (∑ y1 x1 ∑ x1 x2 )  b2 =   ∑ x12 ∑ x22 − (∑ x1 x2 ) 2   = (−10 .621 X 54 .=-0.232 (7.27 ( 48 .962 X −17 .8611 = =-0.

267 =0.304 ) 10 − 3 =2.124 ) = 10 .7% Calculation of variance and standard deviations Variance is given by.87 (94 .724 e δ =∑ 2 u 2 1 n−k ˆ Variance of b0 = δu2 2 2 2 2 ˆ = δ 2  1 + X 1 ∑ 2 + x ∑ x1 − 2 x1 x2 ∑ x1 x2  b0  u  ∑ x12 ∑ x22 − (∑ x1 x2 ) 2 n  28 .277 =27.87 30 .355 53 .= 18962 =0. e δ =∑ 2 u 2 1 n−k 2 1 But ∑e = ∑ y1 (1 − R 2 ) Then δ u2 = = ∑ y (1 − R 1 2 ) n−k 27 .4(1 − 0.46 ˆ b1 ∑x1 y1 Ry 1 x 2 = 2 (∑x 2 ∑ y12 ) = 10 .825 x 28 .

724 x101 .825 )] + [( 48 .63) (54 .371 − 289 .33 .724 x 49 .63 x 48 . ˆ ˆ S (b0 ) = Var b0 = 133 .018 =1.015 ) 2    1 [3191 .825 )] − (17 .621)] − [ 2 x 7.85) (101 .07  1 = 2.861  10  = 2.2 2 ˆ = 2.724  + 5281 .724  1 + [( 7.525 =11 .621 5281 .0524 = 0.510 10  258376 .849  = 2.  ∑ x12 ˆ =δ 2 Var b1 u  2 2 2   ∑ x1 ∑ x2 − (∑ x1 x2 )  = 2.724  +  6571 . 29 .525 Standard Deviation.621)(54 .85 x − 17 .0524 ˆ ˆ S (b2 ) = Var b2 = 0.742 + 242500 .479 ] + 12683 .555 ˆ Variance of b1 is.861 = 0.229 ˆ Variance of b2 is.015 ]  var b0 10  [(101 .

825 5281 .168 Calculation of the tc and the test of its significance.724 x54 .751 30 .0283 =0.68 11 . ˆ H 0 : b0 = 0 ˆ H 1 : b0 ≠ 0 tc = ˆ b0 ˆ S (b0 ) = −8. Hypothesis to test for b0.555 = −0.  ∑ X 22 ˆ =δ 2 Var b2 u 2  2 2  ∑ X 1 ∑ X 2 − (∑ X 1 ∑ X 2 )    = 2.861 =0.0283 ˆ ˆ S (b2 ) = Var b2 = 0.

013 ˆ Hypothesis testing for b2 ˆ H 0 : b2 = 0 ˆ H 1 : b2 ≠ 0 tc = ˆ b2 ˆ S (b2 ) = − 0.168 =-1.607 31 . ˆ H 0 : b1 = 0 ˆ H 1 : b1 ≠ 0 tc = ˆ b1 ˆ S (b1 ) = − 0.ˆ Hypothesis testing for b1 .27 0.229 =-1.232 0.

APPENDIX II CHARTS AND GRAPH 32 .

1992. July. Ltd. 6. New York Golgotia Publications. CBS. pvt. 8th June 2005 2. Performance and Policy. Economics. Business Weekly. Robert E. Monthly Review. 2004. CBS. Shapiro Edward. The Standard Business. May 2005. and John B.C. 5th Ed. 2005. CBK. Annual Report. Yohe.REFERENCES 1. 5. 7. Samuelson M. 8. 3.T. Study Guide to Accompany Samuelson – Nordhaus Macroeconomics. Tuesday. Chicago: Chicago University Press. CBK. Moguru Tom. Daily Nation. Macroeconomics: Theory. Oxford Press. 33 . Gary W. 1990. Macroeconomic Analysis. Friday 15.H. 9. 4. “Inflation Threatens Growth Forecast” in. 1994. CBK. Economic Survey. CBK. New York. 2005.

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