Commodity Price Shocks and Inflation in a Net Oil‐Importing Economy

The global economy experienced sharp spikes in food and oil prices in 2008–2009 and 2011 period. Oil prices and food price shocks are believed to have played a prominent role in the build‐up of persistent inflationary pressures in Kenya in the recent past. This study uses Granger causality and structural vector autoregressive (SVAR) methods to examine the dynamic linkages between commodity prices and both overall inflation and non‐food non‐fuel inflation. The study finds a significant role of oil and food prices in both measures of inflation. Specifically, the study reveals that food prices are more important than oil prices in explaining overall and non‐food non‐fuel inflation when both variables are considered in the same VAR framework. However, the effect of oil prices on inflation is more persistent than the effect of food prices. The paper also finds that the food and oil inflation effects have more significant influence on non‐food non‐fuel inflation than money supply growth rate and that oil price shocks immediately depreciate the exchange rate. Based on the results, the study recommends adoption of measures to reduce oil dependence, usage of targeted intervention rather than tax waivers during crisis periods, strengthening of supply response measures and a neutral monetary policy stance in the face of shocks unless they get entrenched in the non‐food non‐fuel inflation.