The Dynamics of Exchange Rate Pass-through to Consumer Prices in Tanzania: Pre- and Post-Liberalisation Analysis

Abstract

This study examines the relationship between exchange rate pass-through and inflation in Tanzania from 1988 to 2023, highlighting the effects of exchange rate fluctuations on consumer prices within an open economy. The Vector Error Correction Model indicates a significant long-term relationship between exchange rates and inflation. Granger causality tests demonstrate a bidirectional causal relationship between exchange rates and inflation, alongside a unidirectional influence from exchange rates to money supply, highlighting the significant impact of exchange rate dynamics on inflationary trends. Impulse response functions show that while the immediate effect of exchange rate shocks on inflation is modest, it intensifies over time and stabilises thereafter. Variance decomposition further identifies money supply as a key driver of inflation, particularly in the long run. Prior to liberalisation, ERPT was weak and statistically insignificant; post-liberalisation, however, it became negative and persistent, suggesting that stronger monetary policy frameworks and enhanced central bank independence have moderated inflationary pressures. The findings highlight the significance of exchange rate stability in maintaining price control and affirm the effectiveness of liberalisation in strengthening Tanzania’s monetary transmission mechanism.