KENYATTA UNIVERSITY.

CURBING INFLATION FOR ECONOMIC

GROWTH: THE CAUSES OF
PERSISTENTLY HIGH INFLATION RATES
IN KENYA.

MOGERE EMMANUEL ANYEGA

K16/ 2324/ 2008

SCHOOL OF ECONOMICS

UNIT NAME: RESEARCH METHODS

UNIT NAME: EAE 300

LECTURER: MRS. PEREZ ONONO

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CHAPTER 1:

INTRODUCTION.

1.1 BACKGROUND.

This study considers the reasons behind the persistently high inflation rates in Kenya. The
government of Kenya has stated strongly it is committed to attacking the country’s severe
problems of poverty and unemployment even among those that do presently have jobs. At the
same time, as the Economic Recovery Strategy emphasizes, the government is also committed
to maintaining a low inflation environment is a necessary foundation for attacking poverty,
unemployment and underemployment in a sustainable way.

The government’s objective is to continue reducing the rate of inflation, thereby promoting a
sustained growth of output and employment within the economy. However, a close study of
the Kenyan economy reveals staggering inflation rates which have permeated over the years
with some very astronomical implications on various variables in the economy such as
employment and income distribution within the country.

In 1995, the rate of inflation was 1.6 percent (according to the Kenya National Bureau of
Statistics) down from a staggering 46.0 percent in 1993. After 1995, inflation shot up again and
was into double digits by 1997 on the heels of political unrest, tribal differences, poor
governance, environmental shocks, and a host of other problems.

In 2002, a new government came into power and inflation tumbled to 2.0 percent, only to rise
back into double digits by 2004 and even higher up to the recent past. Over the years the
subsequent governments have introduced various policies both fiscal and monetary with the
aim of curbing the high levels of inflation which up to the recent past seemed not to work.

The changes in the inflation rate in Kenya between the year 2003 and 2010 are as shown below;

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 INFLATION RATE: 20.5 %( 2009est) 26.2 %( 2008est)

PERCENT DATE OF
YEAR INFLATION RATE CHANGE INFORMATION
2003 1.90% 2002 est.
2004 9.80% 415.79% 2003 est.
2005 9.00% -8.16% 2004 est.
2006 10.30% 14.44% 2005 est.
2007 10.50% 1.94% 2006 est.
2008 9.70% -7.62% 2007 est.
2009 26.30% 171.13% 2008 est.
2010 20.50% -22.05% 2009 est.

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A graph representing Kenya’s average inflation rates over the years is as shown below;

From the data and graph presentation it is quite evident that despite the fact that we can say
Kenya is currently going through its best spell in terms of the rate of inflation there is no single
time that inflation can be said to be nonexistent.

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Studies have shown that it is advisable to keep inflation rates as low as possible to allow for
economic growth. Some of the effects of inflation include;

1. Inflation redistributes income in the favor of the rich and the profiteer class at the
cost of the poor masses - the wage-earners and consumers.

2. Through its redistributive effects, inflation increases the inequality of income in the
community by widening the gulf between higher income groups and lower income
groups.

3. The rich become richer and the poor become poorer during inflation.

4. Inflation is regressive in effect in the sense that it hits hard those who are already
weak and cannot protect themselves. It is specially the middle class which suffers
most due to inflation.

5. Inflation is unjust because it affects different classes of people in society in different

ways and different degrees .if inflation were to affect everyone in the society in
exactly the same manner and to the same degree, it would not alter the economic
and social relationships in the community. But inflation takes away wealth from
some people and transfers to others arbitrarily without taking into consideration
the sound maxim of social equity.

6. Inflation is also unjust because it breaks public morale. From the point of view of
social ethics, inflation is always demoralizing; it introduces the spirit of gambling. It
promotes speculation, hoarding, and diverts business skill and efficiency from
productive purposes to speculative purposes.

7. Inflation erodes real savings by deterioration in the value of money.

8. Inflation creates money illusion and generates artificial prosperity, which is not
permanent.

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1.2 PROBLEM STATEMENT.

There are various definitions to the term inflation though it is universally agreed that inflation
occurs due to unexpected rise in the supply of money which causes devaluation or decrease in
the supply of goods and services. Inflation can be defined as the process in which the average
level of prices increases at a substantial rate over a considerable period of time; one can
measure the rate of inflation as either the annual percentage rate of increase in the average
price level or decrease in the value of money.

When the economy of a country faces inflation, it brings bad news for the people because
the supply of goods decreases and this scarcity causes a predicament for the people. High
inflation is not a desirable end in itself. Given the choices between high inflation and strong
economic growth or low inflation and equally robust growth, policymakers should opt for
low inflation. However, it is important to examine the premise that low inflation rates are
by themselves, conducive to economic growth. Thus it’s not surprising to find cases where
there is low rate of inflation in a period of an economic boom.

In that respect, this study seeks to determine the causes of these highly undesirable rates
of inflation in Kenya. There have been numerous theories on how to defeat inflation and
even some theories on whether, or not, it should be defeated at all. Some say that inflation
is not only expected, but also often, needed. Economists believe that in order for the
economy to expand and grow, there has to be some level of inflation. Therefore, the
opposite holds true as well. If you want to lower inflation, you have to accept a semi-
standard economy. They call this tradeoff the Phillips Curve. The Phillips Curve is thought
to be the “proper” way of balancing economic growth and inflation. For this reason the
Central Bank is always looking for the perfect equilibrium at which we can maximize our
economic growth while keeping inflation as minimal as possible. They do this by increasing
and decreasing interest rates. Although, Economists and the Central Bank abide by the
Phillips Curve as a general rule for not letting inflation get out of hand, it has been proven

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many times in the past that it is possible to have a very healthy and prosperous economy
without raising inflation at all.

Ultimately, of course, inflation is a consumer issue with high inflation eroding purchasing
power. Kenya's experience, though, demonstrates how many other factors can combine to
destabilize economic functions. In Kenya's case the lack of a stable political infrastructure is
particularly telling.

In a developing country such as Kenya, high inflation is symptomatic of systemic problems

rather than exclusively economic problems. With a 2001 unemployment rate estimated by
the Central Intelligence Agency at 40 percent, and 2000 population below the poverty line
estimated at 50 percent, Kenya shares the fate of other developing countries with a
dualistic structure-that is where the rural and urban poor are so overwhelmingly
disenfranchised that almost no amount of "reform" or macroeconomic wizardry is going to
change the basic "haves" and "have not’s" market structure.

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1.3 THE RESEARCH QUESTIONS.

1. What is the relationship between inflation and economic growth?

2. Can our economy grow without inflation?

3. What are the effects and causes of persistently high inflation rates? What can the
government do to curb the high rates of inflation?

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1.4 OBJECTIVES OF THE STUDY.

GENERAL OBJECTIVES.

1. To determine the causes of persistently high inflation rates.

2. To identify the relationship that exists between economic growth and inflation rates.

SPECIFIC OBJECTIVES.

1. To ascertain the most appropriate an acceptable level of inflation in a country.

2. To establish the role that the government can play to reduce inflation so as to foster
economic growth.

1.5 SIGNIFICANCE/ JUSTIFICATION OF THE STUDY.

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The study seeks to find out the reasons behind the persistently high inflation rates in
Kenya. This is important in public policy making in order to determine the possible causes
of inflation rates and establish an effective and co-ordinated response to these causes. The
result of this study is relevant for use by the Central Bank of Kenya and other economic
policy making bodies in Kenya.

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1.6 SCOPE AND LIMITATIONS TO THE STUDY.

SCOPE.

The main purpose for this study is to establish the causes of persistently high rates of
inflation in Kenya and how this can be reduced. The research will consider only the
persistency of inflation rates and their relationship with economic growth.

LIMITATIONS.

1. Budgetary constraints: Gathering and processing data is very expensive. This

researcher will therefore be forced to rely on data that is less than ‘perfect’ but that
can be accessed more cheaply e.g. from secondary sources.
2. Time constraint: Collection of data involves too much of time. The researcher will
therefore be constrained by the amount of time available since she will be attending
classes alongside carrying out the study.
3. Availability of locally generated data relevant to the study is a limiting factor in the
attempt to carry out the study comprehensively.

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