Exchange rate policy and inflation: The case of Uganda

This paper examines the determinants of inflation in Uganda. High inflation, an economic virus of the Ugandan economy for most of the 1 980s, has been recorded at annual rates of less than 10% since 1993/94. A competitive exchange rate has also been sustained since 1990. The paper analyses the relative importance of monetary, cost/push and supply-related causes of inflation. A striking observation of the study is that inflation in Uganda is persistently a monetary phenomenon the monetary financing of the fiscal deficit is the main cause of sustained inflation in the economy. In addition to the links between fiscal deficits and monetization, the study investigated the causal relationship between the exchange rate and fiscal balance. The major conclusions are that monetary expansion as dominated by the financing of the fiscal deficit is instrumental in determining the pace of inflation. The exchange rate continues to be a key policy tool. During the 1 980s parallel exchange rate induced inflation was significant. Since liberalization of the foreign exchange market in 1990, there still remains a heavy focus on the exchange rate policy as key to maintenance of macroeconomic stability. It is suggested that the exchange rate policy tool should be used together with appropriate monetary and fiscal instruments so as to enable domestic and external stability of the Ugandan economy.