Inflation Dynamics in Egypt: Does Egypt’s Trade Deficit Play a Role?

Abstract

The objective of this study is twofold; first, to analyze the dynamics of inflation in Egypt by investigating the importance of the different sources of inflation over the past thirty years; second, to detect the impact–if any–of Egypt’s chronic trade deficit on inflation in Egypt. Moreover, the paper attempts to use the empirical results concerning the efficacy of the interest rate and exchange rate channels in testing Egypt’s readiness for inflation targeting (IT). The paper uses Granger causality tests, a variance autoregressive (VAR) model, impulse response functions (IRF) and variance error decomposition (VDC) analyses to test for the sources and dynamics of inflation in Egypt. Results of the paper prove that inflation in Egypt is primarily affected by the rate of growth of money supply. Although the interest rate channel has proved to influence inflation, its influence comes second after money supply as a determinant of inflation