This paper explores the sources of inflation in Sub-Saharan Africa by examining the relationship between inflation, the output gap, and the real money gap. Using heterogeneous panel cointegration estimation techniques, we estimate cointegrating vectors for the production function and the real money demand function to recover the structural output and money gaps for seventeen African countries. The central finding is that both gaps contain significant information regarding the evolution of inflation, albeit with a larger role played by the money gap. There is no significant evidence of asymmetry in the relationship.
Rapid output growth and low inflation are the most common objectives of macroeconomic policy. It is rather surprising, therefore, that a consensus about the relationship between these two variables is yet to emerge. While early studies by Phillips (1958) suggested an exploitable trade-off between output and price stability, the stagflationary experience of the industrialized countries in the 1970s belied this finding and showed that, beyond the short run, any such trade-off is illusory. More recent cross-country studies, particularly those that include middle- and low-income countries in their samples, suggest a negative relationship between growth and inflation.1 Even among these studies, however, there is little agreement on whether the empirical association of lower inflation with faster growth is statistically and economically significant, let alone causal.2