Effect of Public Debt on Inflation in Kenya: An ARDL Approach

Abstract

Aspects contributing to inflation warrant consideration in attaining price stability, especially for an economy facing escalating public debt levels. Kenya's public debt has been increasing significantly, raising concerns about its potential impact on inflation dynamics. The specific objectives of this research were to determine public debt trends in Kenya, assess historical inflation patterns, and analyze the effect of public debt on inflation. The study was founded on the Fiscal Theory of Price Level (FTPL), the Classical Quantity Theory of Money, and the Monetarist Theory, highlighting the interplay between fiscal and monetary policy in influencing price levels. The researcher applied descriptive, causal, and correlational research designs to provide a comprehensive analysis of the relationship among variables. The analysis entailed trend analysis to observe the trajectory of public debt, the Hodrick-Prescott (HP) Filter to isolate inflationary patterns, and the Autoregressive Distributed Lag (ARDL) Model coupled with the bounds cointegration test to examine the long-term relationships among variables. An error correction model was used to measure the speed at which inflation returns to equilibrium. The study utilized quarterly secondary time series data from 2000 to 2022, ensuring a robust dataset for examining both short-term and long-term effects. Stationarity tests confirmed that inflation, public debt, money supply, exchange rate, and GDP series were integrated at the first order, while the 91-day treasury bills interest rates series was integrated at level (order zero). Trend analysis indicated that government borrowing in Kenya is on a sustained upward trajectory. The HP Filter findings demonstrated that inflation in Kenya exhibits minimal cyclical pressure, suggesting structural factors dominate. The ARDL bounds test confirmed a long-run association among all variables; however, the model failed to reject the null hypothesis, implying that public debt does not significantly affect inflation in Kenya. Past values of inflation, money supply, and 91-day treasury bills interest rates significantly influence inflation only in the short run. An Error Correction Term of (–0.008) reveals a very slow adjustment process, requiring policymakers to adopt both short-term inflation-targeting interventions and long-term macroeconomic stabilisation policies.