Inflation Dynamics in Zambia

This study assesses the empirical drivers of inflation in Zambia over the period 1994.1- 2019.4. A single-error correction model is used in which the underlying determinants of both food and non-food components of inflation as well as supply constraints are incorporated in the overall inflation equation. The empirical results reveal that the long-run sources of overall inflation are determined in the external sector market where the exchange rate and world non-food prices drive domestic prices. In the shortrun, overall inflation is influenced by movements in the exchange rate, adjustments in energy prices, imported inflation from South Africa, and changes in maize prices (supply constraints). In addition, the results show that overall inflation exhibits persistence and seasonality. Further, the two sub-components of inflation display different characteristic behaviours. This underscores the importance of employing a disaggregated approach to modelling inflation in order to improve information content and policy response. Three policy lessons can be drawn from these empirical results. The dominant influence of the exchange rate on overall inflation and its subcomponents deserves serious policy attention requiring consistent actions to dampen excessive depreciation of the Kwacha against the US dollar. In the case of the passthrough from imported inflation, expanding and diversifying the manufacturing base to limit the current high dependence on imports of final consumer and capital goods remains a policy priority. Finally, the role of supply shocks evident in the impact of maize prices on inflation necessitate immediate significant reforms in the agriculture sector to boost productivity through the use of modern techniques such as irrigation in order to reduce dependence on rain fed practices.