Re-Estimating Inflation Threshold Level for Tanzania

Abstract

The study seeks to estimate the relationship between inflation and economic growth, as well as the headline inflation threshold level beyond or below which Tanzania’s economic growth is constrained. This was achieved through the Ordinary Least Squares (OLS) regressions employing quarterly data spanning the period 2001:1 to 2021:4. The findings suggest that the coefficient of inflation variable that captures the effect of low inflation on growth is statistically significant and positive, implying that low inflation is pro-growth. One percent increase in inflation leads to an economic growth of 0.352 percent. Furthermore, the coefficient of the high inflation proxy variable has a negative sign with the inflation threshold level being seven percent. At this level, the total effect of inflation on growth is estimated at 0.3494 percent.  Moreover, optimal inflation levels of one to three percent have no impact on growth, as mirrored by invariable adjusted R².

The recommendations from the results of this study are three-fold. First, the Bank of Tanzania may consider inflation targets below seven percent but above three percent in the monetary policy planning to continue supporting economic growth. Second, since the Bank has largely depended on inflation behaviour in informing inflation targets to choose, which ended into picking targets far from the optimal inflation, it is essential that the Bank also benefits from empirically estimated threshold rates. Third, in order to utilize any new information emanating from structural changes and developments in the economy, inflation threshold level should be re-estimated regularly.