Workshop: Energy Prices and Inflation in Tanzania

At a recent event held in collaboration with the Bank of Tanzania (BoT), Chris Adam, IGC Tanzania Lead Academic, presented recent research findings on the pass-through of global energy prices to inflation in Tanzania, and on the link between energy (and transport) costs and longer-run structural change in the Tanzanian economy. The event was attended by over 30 stakeholders from the BoT, Government departments and independent research bodies.

Energy prices are the most volatile component of the Consumer Price Index (CPI), and effective inflation forecasting requires good models of how changes in energy prices pass-through to inflation. To investigate how global energy prices impact Tanzanian inflation as a whole, Adam presented evidence on the direct pass-through to domestic energy prices, and indirect pass-through to other elements of the CPI basket.

Domestic energy prices in Tanzania broadly follow world energy prices over the long-run; but the relationship is much weaker in the short-run. Investigating this short-run relationship, Adam presented evidence for asymmetric price responses in the fuel market: domestic fuel prices seem to adjust upward much more quickly when the world price exceeds the domestic price, than they adjust downward when domestic prices exceed global prices.

As energy prices account for a relatively small proportion of the total basket of goods and services that are used to construct the CPI, the direct effect of global energy price shocks on total, headline inflation is small. However, because energy is an important intermediate input for other goods and services, energy price changes have a much larger indirect effect on inflation. Analysing this channel through input-output relationships suggests that a 1% increase in energy prices may raise headline CPI prices by around 0.6%. However, this would require full pass-through of input costs to output prices, which is unlikely to be the case – for example, higher energy prices: will induce some input substitution; will reduce demand and hence price pressures by bearing down on real incomes; and may also induce a monetary policy response. Econometric estimates, which will implicitly take such factors in to account, suggest that a 1% increase in domestic energy prices translates into a 0.2% increase in non-energy prices.

The seminar concluded with some observations on the link between energy (and transport) costs and longer-run structural change in the Tanzanian economy. As a large country with a low population density and poor infrastructure, energy and transport costs are particularly damaging to Tanzania’s growth and development. Recent work by Adam, Bevan, Gollin and Mkenda (2012 and 2013) explores the consequences of a reduction in transport costs on the spatial distribution of economic activity, rural-migration and welfare. It shows that improved transport infrastructure can have across-the-board benefits, and suggests that the strongest impact will be on the well-being of the unskilled – with a key mechanism being that improved market integration (via lower transport costs) allows efficient rural-urban migration.

Please see a copy of the slides below.