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Title: An Empirical Investigation of the Causes of Inflation and the Applicability of Inflation Targeting in Mozambique
Authors: Riaz Mahomed, Mahomed
Issue Date: 15-Feb-2007
Series/Report no.: UCM/MA/05/019
Abstract: The aim of the study is to identify the causes of inflation and evaluate the applicability of Inflation Targeting (IT) in Mozambique as a mean to control inflation. The study is based on the fact that inflation in Mozambique in the last years has been reaching two digits level,although Central Bank of Mozambique (BM) announces that the expected inflation rate would be of one digit. This scenario gives room to question both the driving factors influencing inflation in Mozambique and the monetary policy being used by BM to curb inflation, in this case monetary targeting. In order to attain the two objectives, first a model for causes of inflation was fitted where inflation or price level (CPIMZ) is a function of money supply (M2), real income (Yr) and exchange rate depreciation, measured by exchange rate of Metical in relation to South African Rand (eZAR). Second, the stable and predictable relationship between inflation and monetary policy instruments was evaluated and the variables used were the same with addition of nominal interest rate on 3 months time deposits (NIR). In both cases stationarity tests, cointegration and Error Correction models (ECM) were used in order to evaluate stationarity, long run relationship and existence of short run disequilibrium, respectively. Regarding the model of inflation, all the variables were found very significant explaining inflation behaviour in Mozambique, where Yr is the major driving factor of inflation in Mozambique, followed by eZAR and M2. Related to the applicability of IT in Mozambique, again cointegration among variables was identified except for NIR because the interest rate policy in Mozambique has suffered several changes from the past 15 years. Conclusively, inflation in Mozambique is driven by Yr, M2 and eZAR, reinforcing the classical sources of inflation. Note that Purchasing Power Parity (PPP) was assumed to hold; therefore eZAR captures the effect of foreign prices in the Mozambican economy and consequently affects inflation as well. Regarding applicability of IT, it can be applied since cointegration between inflation and monetary policy instruments was identified. Although central bank independence and having a sole target were not evaluated, because it would have involved legislation survey which is out of the scope of the current study, IT can be applied by BM as a mean to control inflation.
Description: Thesis Submitted in Partial Fulfilment of the Requirements for the Master of Arts (MA) Degree in Economics and Management
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