Domestic and External Determinants of Inflation: An Empirical Investigation for Egypt

This paper investigates the relationship between inflation in and a set of domestic and external factors to provide an assessment of the determinants of inflation dynamics in Egypt. The analysis adopts ordinary least squares (OLS) and quantile regression based on monthly data for headlines and core inflation from 2005 to 2024. A nonlinear auto regressive distributed lag (NARDL) is conducted to explore the asymmetric impacts for determinants in the short run and the long run. Finally, the paper uses forecast analysis within multivariate models to explore the future path of inflation after different shocks in explanatory variables. The results demonstrate that the main significant variables that help explain inflationary pressures are monetary financing, banking sector financing to the government, and the volatility of the exchange rate. There is also an asymmetric effect for exchange rate changes in the short run, where depreciations result in significant increases in inflation. Furthermore, the interest rate tool of monetary policy becomes ineffective at high levels of inflation. This has critical policy implications, shedding light on the role of unconventional monetary policy tools like forward guidance, asset purchases, and term funding facilities in curbing inflation. Priorities for policymaking should include reducing budget deficits, as ensuring a sustainable path of the fiscal deficit would curb the rising inflation. Finally, given the significance of monetary financing and banking sector financing to the government in explaining inflationary pressures, effective implementation of inflation targeting as a framework for monetary policy can contribute to stabilizing inflation rates, as it implies freedom from fiscal dominance and limiting excessive monetary growth.