Relationship between Kenya’s economic growth and inflation

This study estimates the threshold level of inflation for Kenya using 49 years of annual time series data for the period 1971 to 2019. First, the estimated threshold level of inflation was obtained using the threshold regression method and, second, by use of an augmented regression model with inflation at structural breaks. Lastly, an econometric analysis of the restricted parametric model was used to verify the validity of each of the estimated threshold levels of inflation obtained from the two techniques. The threshold regression method estimated a statistically significant threshold inflation rate of 5.83%. An augmented regression model with inflation at structural breaks predicted a statistically insignificant threshold inflation rate of 5.7%. The restricted parametric model established a statistically significant positive effect and negative effect for the threshold inflation of 5.8% and 5.7%, respectively. At threshold inflation of 5.8% and 5.7%, a unit increase in inflation improved GDP growth by 2.89% and decreased GDP growth by 3.29%, respectively. Therefore, the estimated threshold inflation of 5.8% obtained by the threshold regression method gives a better prediction than the estimated threshold inflation of 5.7%. The study recommends that the central bank of Kenya pursues inflation below 5.83% to boost economic growth.