GLOBAL OIL PRICE VOLATILITY AND INFLATION IN KENYA: A SVAR APPROACH
Christine Moragwa - MSc. Economics Candidate, Department of Economics, School of Business and Economics, Daystar University, Kenya
Laban Chesang, PhD - Lecturer, Department of Economics, Dean, School of Business and Economics, Daystar University, Kenya
Jimnah Waweru - Lecturer, Department of Economics, School of Business and Economics, Daystar University, Kenya
Charles Katua Kithandi - HoD, Department of Economics, School of Business and Economics, Daystar University, Kenya
ABSTRACT
Inflation is one of the central variables in macroeconomic management, and for a net oil-importing economy such as Kenya, movements in global crude oil prices are a recurrent source of inflationary pressure. The purpose of this study was to examine the impact of global oil price volatility on inflation in Kenya. The study was anchored on the Expectations-Augmented Phillips Curve, supported by Monetarist Theory and the Quantity Theory of Money. A descriptive, causal and correlational research design was adopted using annual secondary data for the period 1970 to 2022 obtained from the World Bank, the Federal Reserve Economic Data (FRED) and West Texas Intermediate (WTI) crude oil prices. Oil price volatility was measured using the Average True Range (ATR), while gross domestic product, government spending, money supply and the exchange rate served as control variables. Stationarity was confirmed using the Augmented Dickey-Fuller and Phillips-Perron tests, and a recursively identified Structural Vector Autoregressive (SVAR) model with one lag was estimated, from which impulse response functions (IRFs) and forecast error variance decomposition (FEVD) were derived. The IRFs show that a one-standard-deviation shock to oil prices and to oil price volatility each causes a significant rise in inflation within the first year, after which the effect fades and becomes statistically insignificant from about the second year. The FEVD shows that oil prices explain 12.9% and oil price volatility 10.5% of the variation in inflation in the first year; over ten years, oil price volatility accounts for about 11.6% and oil prices about 6.4%, while the exchange rate becomes the dominant external driver (about 34%). The study concludes that global oil price shocks exert a significant short-run influence on inflation in Kenya that dissipates as economic agents adjust their expectations. The study recommends that the Energy and Petroleum Regulatory Authority (EPRA) and the Central Bank of Kenya institute measures that cushion the economy during oil price fluctuations, alongside diversification towards renewable energy.