joel's research

i

IMPACT OF INFLATION ON AGRICULTURAL PRODUCTION: CASE OF

COFFEE PRODUCTION TANZANIA 1980-2010

By

Chilambo, Joel.

2610/T.2010

A dissertation Submitted in Partial Fulfillment of the Requirements for the Degree

of Bachelor of Arts in Economics of the University of Ardhi.

Ardhi University.

Ardhi University

School of urban and Regional Planning

P.O.Box 35176

Dar Es Salaam

June 2013

ii

CERTIFICATION

The undersigned certifies that he has read and hereby recommends for acceptance by the

University of Ardhi, a dissertation entitled: “Impact of Inflation on Agricultural

Production: Case Of Coffee Production Tanzania 1980-2010”, in Partial Fulfillment of

the Requirements for the Degree of Bachelor of Arts in Economics of the University of

Ardhi.

Signature

_____________________

Mr. Temu, D.

Date _________________________

iii

DECLARATION AND COPYRIGHT

I, Chilambo, Joel, declare that this dissertation is my own original work and that it has

not been presented to any other University for a similar or any other degree award.

Signature:______________________

iv

AKNOWLEDGEMENT

Gratefully, much thanks to Lord God who created the livings and non-livings for His

Mercy upon on strengthening my effort and provision of understanding throughout the

working on this task. Secondly I would like to express my gratitude to my supervisor Mr.

Temu D for his guidance, patience and encouragement on the way to accomplish this

task.

Also special thanks to my colleague of UWATA Mabibo hostel; Peter Mwandendi,

Patrick Saukiwa, Moses Mwalyolo, IsayaMkandawile, Ronald Wikence, Huruma

Michael, Adela Mafumiko, Diana stambuli to mention and all UWATA members for

their full support.

I would like to express my gratitude to my beloved mother AdelinaChilambo, without

forgetting Flora Chilambo, Joseph Chilambo and the whole Chilambo family for their

pleasing hearts in my education progress. Any mistake in this desertation, however,

remains entirely mine.

v

DEDICATION

This dissertation I dedicate to the following my Mother AdelinaChilambo, her sister

Flora Chilambo with their brother Joseph Chilambo for their endeavors, encouragement

and sacrifices they made to my achieving successes.

To Mr. and Mrs. Chieti, Mr. and Mrs. Gideon Mwangalika, Mr. and Mrs. Peter Mgao,

Mr. and Mrs. Michael Mwakasole, Miss Joyce Katanga, Miss Vumilia Kilave, Miss

FarajaChilambo and Veronica Chilambo for their full support.

To my grandfather Felix E Chilambo with my grandmother Filomena A Luoga who spare

their life and effort for my success.

To Jesus Christ and the whole Church of Christ.

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ABSTRACT

This study is empirically investigate the impact of inflation on crop production

specifically on coffee production in Tanzania from 1980-2010. The study uses time series

data, employing Co integration and Error Correction Mechanism (ECM). The empirical

results show that there is insignificant impact of inflation on crop production in Tanzania;

this indicates that inflation is either not good indicator to measure inflation in Tanzania.

The study concludes that though insignificant impact of inflation on crop production, the

government should assure long-term economic stability in the economy for effective

production in the economy.

vii

TABLE OF CONTENTS

CERTIFICATION ........................................................................................................... II

DECLARATION AND COPYRIGHT ......................................................................... III

AKNOWLEDGEMENT................................................................................................. IV

DEDICATION.................................................................................................................. V

ABSTRACT ..................................................................................................................... VI

LIST OF TABLES ............................................................................................................ X

CHAPTER ONE ............................................................................................................... 1

INTRODUCTION............................................................................................................. 1

1.0 Background ................................................................................................................... 1

1.2 Statement of the Problem .............................................................................................. 7

1.3 Objectives of the Study ................................................................................................. 7

1.3.1 Specific Objectives .................................................................................................... 8

1.4 Research Question(S).................................................................................................... 8

1.5 Significance of the study ............................................................................................... 8

1.6 Organization of the Study ............................................................................................. 8

CHAPTER TWO .............................................................................................................. 9

AN OVER VIEW OF INFLATION, AGRICULTURAL PRODUCTION AND

COFFEE PRODUCTION IN TANZANIA .................................................................... 9

2.0introduction .................................................................................................................... 9

2.1.0inflation Trend Before and After Economic Reforms of 1980s ............................... 10

2.1.1measures Taken by the Government to Control Inflation ......................................... 11

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2.2 Agricultural Sector Performance Since Independence and Current Situation ............ 12

2.3.0 Coffee Production Trend and Development Since Independence ........................... 14

2.3.1 Factors that Influence Coffee Production in Tanzania ............................................ 14

CHAPTER THREE ........................................................................................................ 15

LITERATURE REVIEW .............................................................................................. 15

3.0 Introduction ................................................................................................................. 15

3.1 Theoretical Literature Review .................................................................................... 15

3.2 Empirical Literature Review ....................................................................................... 17

CHAPTER FOUR ........................................................................................................... 20

METHODOLOGY ......................................................................................................... 20

4.0 Introduction ................................................................................................................. 20

4.2 Model Specification .................................................................................................... 20

4.3 Measuring Inflation ..................................................................................................... 21

4.4estimation Procedure .................................................................................................... 22

4.4.1 Unit Root Test .......................................................................................................... 22

4.4.2 Error Correction Model............................................................................................ 22

4.5 Data Type And Source ................................................................................................ 23

CHAPTER FIVE ............................................................................................................ 24

EMPIRIC RESULTS AND THEIR INTERPRETATION......................................... 24

5.0 Introduction ................................................................................................................. 24

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5.1 Statistical Properties Of Data ...................................................................................... 24

5.1.1 CORRELATION ANALYSIS BETWEEN INFLATION AND COFFEE GROWTH RATE ..... 25

5.1.2 Test for unit Root (Stationary of Data) .................................................................... 25

5.1.3 Test for Co Integration ............................................................................................. 26

5.2.1 Error Correction Mechanism ................................................................................... 26

5.2.2 Empirics of study ..................................................................................................... 27

5.3 Measures Taken by the Government to Control Inflation in Tanzania; ..................... 27

5.4 Other Factors than Inflation that Influence Coffee Production in Tanzania ............... 28

CHAPTER SIX ............................................................................................................... 30

CONCLUSION, POLICY IMPLICATION AND RECOMMENDATIONS ........... 30

6.1 Main Findings ............................................................................................................. 30

6.2 Policy Implication and Recommendations ................................................................. 30

6.3 Limitation of the Study and Recommendation ........................................................... 31

REFERENCES: .............................................................................................................. 32

APPENDICES ................................................................................................................. 35

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LIST OF TABLES

Table 1Inflation trend …………………………………………………………...….7

Table 2 Coffee trend…………………………………………………………….....15

Table 3 Statistical properties of data ………………………………………….…..25

Table 4 Correlation table ………………………………………………….….......26

Table 5 Unit root test table ………………………………………………….….....26

Table 6 Unit root test in 1st difference …………………………………..…….…..26

Table 7 Co integration table ……………………………………………………….27

Table 8 Error Correction Mechanism (ECM) table ………………………............27

Table 9 Regression results table ……………………………………………..……28

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LIST OF ABBREVIATIONS

A.D.B African Development Bank

AD Aggregate Demand

ADF Augmented Dickey Fuller Test

AFCP Annual Finance Credit Plan

AS Aggregate Supply

B.O.T Bank of Tanzania

BFIA Banking and Financial institution Act

CC Currency in Circulation

DD Demand Deposit

CPI Consumer Price Index

ECM Error Correction Mechanism

ECT Error Correction Term

FEP Foreign Exchange Plan

GDP Gross Domestic Product

I.M.F International Monetary Fund

M2 Broad Money Supply two

NBS National Bureau of Statistics

OMO Open Market Operation

PPI Producer Price Index

SUA Sokoine University of Agriculture

TCB Tanzania Coffee Board

URT United Republic of Tanzania

1

CHAPTER ONE

INTRODUCTION

1.0Background

Agriculture is the foundation of Tanzania’s economy: contributes almost half of national

income, ¾ of export, 80% of employment. Larger area is cultivated by hand hoe about

70% of cultivated area, 20% by ox plough and 10% by tractor (National website, 2012)

Tanzania is heavily dependency on agriculture account for 26% of GDP according to

2007/08 agriculture sample census compared to 34.8% as reported by 2003 census, this

tries to show declining trend of agricultural production.

Agriculture is not doing well due to low investment in the sector, this results to poor

functioning of the sector, banking sector provision of finance to the sector is to narrow,

from 1994-1998 only 7% (IMF, 1995) of total lending by commercial banks went to

agriculture.

Tanzania’s agriculture depend much on rainfall, small portion of area is under irrigation,

there is limited use of inorganic fertilizer than organic fertilizers this is according to

Tanzania agriculture sample census-2007/2008, This is then led to low productivity of the

sector compared to 2002/2003.

Cash crop production in Tanzania includes the following crops; coffee, cotton, cashew

nuts, sisal, pyrethrum, tea cloves, horticultural crops, oil seeds, spices and flowers. In

case of coffee there are two types of coffee which dominant in Tanzania, they are grown

in different areas such asMbinga-Ruvuma, Mbeya, Kagera, Moshi

Coffee production has a tendency of fluctuating, 1989/90 only 53,420 metric tons were

produced, 2000/01 0nly 58,240 metric tons of coffee were produced, 2000/03 only

50,000 metric tons of coffee were produced (Sokoine University of Agriculture). This

shows slight improvement of coffee production in comparison of effort inverted to it.

2

Coffee production contribution to cash crop production is averagely declining for almost

eleven years from 1997-2008 has declined to 6% (URT 2011/21) share on cash crop

production.

Coffee production is among major export crop, and it contribute income to about 400,000

small households who produce about 95% of total coffee while the rest 5% is produced

by estates, (SUA, 2005). Therefore coffee and cotton are major export cash crops in

Tanzania.

In exportation earning, coffee exportation has significant contribution to other crops in

most coffee exportation country, by 2010 it account about $16.5 billion in the global

economy, and Brazil and Vietnam lead the production of coffee in the world (URT,

2011/21).

Monetary policy and operation in Tanzania are under control of the Bank of Tanzania

which was established under the Bank of Tanzania act of 1965 to control all traditional

function of central banking function.

By 1967 through Arusha declaration the function of Bank of Tanzania become inactive

since all privately commercial banks were nationalized, this made all financial matters

and services to be under control of central planning such as the Annual Finance and

Credit Plan (AFCP) and the Foreign Exchange Plan (FEP) control monetary policy and

operation under government directives, this brought macroeconomic imbalances which

escalate inflation and pull down economic growth.

In 1978 the Bank of Tanzania act of 1965 was amended and Bank of Tanzania were

given its power back and was added with other task in which it was empowered to inspect

and supervise banks and financial institutions which were formerly not included in the

Bank of Tanzania act of 1965.

3

In the late 1980, the Tanzania government under take economic reforms following

macroeconomic instability of 1970s and 1980s. Reform aim to eliminate direct control by

the government over economy and introducing market economy. There was liberalization

of financial sector. Banking and Financial institution Act (BFIA) 1991 was introduced

which allowed private sector in financial sector in Tanzania.

Liberalization of financial sector in the economy followed with the enacting of Bank of

Tanzania Act of 1995 which unpin Bank of Tanzania from multiple objectives to single

objective of price stability where various indirect instrument were introduced such as

Open Market Operation, Repurchase Agreement, Discount Window and Lombard

Facility, Foreign Exchange Market Operation, Statutory Minimum Reserve Requirement

and Moral Sasuation.

Liberalization of financial sector and the use of monetary policy has significant important

role for the success of Tanzania economy whose inflation has declined from 30% in

1990s to lowest level, also economic growth shows successful achieves.

Despite these achievement by Bank of Tanzania, still it faces challenges such as external

shocks which influence its objective, shortcomings in land laws which limits banks to

extend credit to private sector, absence of credit reference system and delays to issue

national identity limit development of financial sector.

Economic, financial reforms and monetary policies in Tanzania has helped to reduce

inflation from over 30% prior 1990 to the current inflation rate, these reform and policies

helps Tanzania in achieving macro and micro economic goals such as economic growth,

real GDP growth for the last decade had increased by 7% (B.O.T, 2011) and this is

attributed by increase in commercial banks which liquidate capital in the economy which

accelerating economic growth and development in Tanzania.

For the sake of increasing coffee production and improving the quality of coffee

Tanzania has launched the Board of Coffee called “Tanzania Coffee Board (TCB)” to

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make the sector better off, the board aim to increase production from 50,000 metric tons

annually to 80,000 tons annually by 2016, and reaching 100,000 metric tons by 2021,

also aim to improve coffee quality from 35% premium coffee to 70% of total production

(URT, 2012).

Africa produces 12% of global produced coffee, while Tanzania produces less than 1% of

total coffee produced globally; by 2011 it shares only 0.6% of total volume of global

production. In the global market there are two types of coffee, which dominate the

market; Arabica and Robusta (URT, 2011/21).

In Tanzania Arabica growing regions are Mbinga-Ruvuma, Mbeya, Arusha, Kilimanjaro

while the major Robusta producer is Kagera, other coffee producing region are Tanga,

Iringa, Morogoro, Manyara, Mwanza and Mara.

Mbeya region is considered as the first mild Arabica producing region with

approximately 12,000 to 15,000 tons annually, it is an expanding coffee growing region

with about 51,000 hectares of coffee, though this region lack improved varieties planting

materials.

Mainly Tanzania produces three types of coffee; washed mild Arabica which present

about 55% of total coffee produced, sundried Robusta 40% of total coffee and sundried

and natural Arabica only 5% of total produced coffee.

Inflation in Tanzania is termed as “The first enemy” by the bank of Tanzania; inflation in

the country is volatile, high rate inflation by December 2011, which went high to 19.8%

due to food and energy prices (ADB, 2011). By 2004 inflation rate was 4.6% and 6.2%

by 2000(Nathan, 2005 and Korindo, 1997)

Inflation rate in Tanzania tend to fluctuate over time even though it has declined by 30%

prior to 1990 currently situation. By 1985 inflation rate was 33.3%, 1990 it was 35.9%,

5

1995 it was 27.4%, by 2000 it was 5.9%, by 2005 it was 4.4% by 2010 it was 7.2%.

These all shows volatility of inflation in Tanzania (B.O.T, 2001)

To curb inflation in Tanzania to suit economic environment through central bank, uses

various approach and instruments, like financing government deficit through open market

operation, introduction of liquidity papers by the central bank as tool of withdrawing

liquidity in the economy to reduce inflation (B.O.T 2011).

Since independence government has passed various strategies and programs to boost up

agriculture sector which were integrated within five years development plans, after

Arusha declaration 1967 agricultural policy environment were characterized by the

government-led intervention (U.R.T)














6








objective of price stability and various indirect instrument were introduced such as Open

Market Operation, Repurchase Agreement, Discount Window and Lombard Facility,

Foreign Exchange Market Operation, Statutory Minimum Reserve Requirement and

Moral Sasuation.














Consider table 1 below;

7

1.2Statement of the problem

Given the fact that Tanzania promote agriculture through various programs, like

“KILIMO KWANZA” through subsidizing agricultural inputs like fertilizers, pesticides,

tractors and other chemicals, still crop production fluctuates.

1989/90 0nly 53,420 metric tons, 2000/01 only 58,240 metric tons of coffee, 2000/03

only 50,000 metric tons of were produced (Sokoine University of Agriculture, 2005).

This shows a slight improvement of coffee production compared to effort done.

Average contribution of coffee to cash crop production is declining, for eleven years

average contribution of coffee to cash crop production from 1997-2008 has declined to

6% share on cash crop production. Given inflation volatility in Tanzania which influence

cost of production there are possibilities for macroeconomic issues to have an influence

on coffee production

1.3Objectives of the study

Overall objective of the study is to investigate impact of inflation on cash crop production

with the following specific objectives

8

To examine the trend of coffee production fluctuation in relation to inflation trend from

1980-2010

To examine measures taken by the government to control inflation in Tanzania

To determine other factors than inflation that influence coffee production in Tanzania

1.3.1Specific Objectives

1. Examining the trend of coffee production fluctuation in relation to

inflation trend from 1980-200

2. Examining measures taken by the government to control inflation in

Tanzania

3. Determining factors influencing crop production in Tanzania.

1.4Research question(s)

1. What are the effects of inflation on agricultural production especiallyon

cash crop production?

2. Which measures taken to control inflation in Tanzania?

3. Which factors influencing crop production in Tanzania especially crop

production?

1.5Significance of the study

The study shall provide insight to policy makers on provision of agricultural policies that

sustain agricultural production even in inflationary environment, since inflation may be

of external influence than shock from within.

1.6Organization of the study

This study is organized into six chapter, in chapter one is an introduction, chapter two

presents an over view of inflation, agricultural production and coffee production in

Tanzania, chapter three literature review on both theoretical and empirical literature

review, chapter four present the methodology of the study, chapter five presents empiric

results and their interpretation and chapter six present conclusion, policy implication and

recommendation.

9

CHAPTER TWO

AN OVER VIEW OF INFLATION, AGRICULTURAL PRODUCTION AND

COFFEE PRODUCTION IN TANZANIA

2.0Introduction





















objective of price stability and various indirect instrument were introduced such as Open

Market Operation, Repurchase Agreement, Discount Window and Lombard Facility,

10

Foreign Exchange Market Operation, Statutory Minimum Reserve Requirement and

Moral Sasuation.














Table of inflation

2.1.0Inflation trend before and after economic reforms of 1980s

Price stability were formerly in stable position, by 1970 it was in lowest level and single

digit about 2.4%, but as the time went on thong became unexpected where inflation by

1973 inflation mounted to double digit about 10.4% and reaching 27% by 1975 though it

then sharply declined by 1976 to 6.3%, the situation change by 1980 where inflation rose

to 30.8% and 36.1% percent by 1984. (BOT,2011)

Hope were shown in 1987 in which inflation rate dropped to 29.9% from 36.6% of 1984,

things went bad in 1990 were inflation rose to 35.9%, but hope mounted in 1996 were

11

inflation dropped to 21%, and the year 1998 was more hopeful were inflation declined to

12.9%(BOT, 2011).

1999 was the year of good hope in Tanzania’s economy since it regain the experience of

single digit inflation about 7.9%, which were not experienced since 1978 which it was

7.0%, it therefore assure the move to the compass of successful economy, it further

dropped to the lowest level to 4.6% by 2002(BOT, 2011).

The year 2008 shows signs of declining and poor functioning of macro

economicvariables where double digit inflation started persisting in which it was 10.3%

and rose to 12.2 by 2009 and was sharply declined by 2010 to 7.2%(BOT, 2011).

2.1.1Measures taken by the government to control inflation

Bank of Tanzania (BOT) has given authority and power to control over money supply

and all monetary issues in Tanzania, aim is to alleviate and controlling general price level

(inflation rate) in the economy which may economic growth and development relative to

other economies.

Tanzania through its central bank uses various deeds to control inflation among the deeds

includes; refinancing policy, minimum reserve requirements, open market policy, foreign

exchange intervention and other deeds (BOT, 2011).

To control inflation in the economy money supply is controlled to large extent especially

M2 that is broad money supply that include currency in circulation and demand deposit,

broad money supply two (M2) is used since it has direct relationship with inflation rate.

Indirect instruments are used by Bank of Tanzania to control inflation in the economy;

these include open market operation (OMO), standing facilities (Lombard and discount

window, repurchase agreement transaction, statutory reserve together with requirement

and moral sasuation.(BOT, 2011)

12

2.2 Agricultural sector performance since independence and current situation

Agriculture is the foundation of Tanzania’s economy: contributes almost half of national

income, ¾ of export, 80% of employment. Larger area is cultivated by hand hoe about

70% of cultivated area, 20% by ox plough and 10% by tractor (National website, 2012)

Tanzania is heavily dependency on agriculture account for 26% of GDP according to

2007/08 agriculture sample census compared to 34.8% as reported by 2003 census, this

tries to show declining trend of agricultural production.

Agriculture is not doing well due to low investment in the sector, this results to poor

functioning of the sector, banking sector provision of finance to the sector is to narrow,

from 1994-1998 only 7% (IMF, 1995) of total lending by commercial banks went to

agriculture.

Tanzania’s agriculture depend much on rainfall, small portion of area is under irrigation,

there is limited use of inorganic fertilizer than organic fertilizers this is according to

Tanzania agriculture sample census-2007/2008, This is then led to low productivity of the

sector compared to 2002/2003.

Cash crop production in Tanzania include the following crops; coffee, cotton, cashew

nuts, sisal, pyrethrum, tea cloves, horticultural crops, oil seeds, spices and flowers. In

case of coffee it is grown in the following areas Mbinga-Ruvuma, Mbeya, Kagera, Moshi

Basic data signifies in agricultural production, food crops has higher production trend

than other agricultural output, this has been the case since much efforts and priorities that

have been put forward toward food production than other non-food production.

In Tanzania, agricultural production is dominated by small holders who to the large

extent is comprising largely with women, though significance of their participation in

agriculture sector is poorly recognized, the government has provided much strategies to

13

improve agriculture to smoothly run agriculture by enacting various policies to boost

agriculture, suchas “Kilimo Kwanza” and as much as more agricultural priorities.

Tanzania government has set various development policies aiming at sustaining

agricultural sector, this is done through provision of conducive and feasible environment

for agriculture to run, in 1997 the livestock policy was introduced, cooperative policy

1998 and national investment policy, and national trade policy 1997. All these aim to

create viable environment for both local and foreign investors to invest in agriculture

sector, paving a way to international market for agricultural products with quality

improvement.

Cooperative development policy 1997, his policy aim at provision of economical

environment that people associate in resource exploitation, this aim at communally use

resources to promote competitive production in agriculture sector for social and

economic development in Tanzania community.

These policies shows significance and responsibility of the government to agriculture

sector as accelerator and facilitator of agriculture through provision of information,

training experts and empowering women on participation in agriculture sector, shows

implementation of specific strategies to boost up agriculture.

Agriculture sector has positive progress, it has significance position in the economy, and

it is among major contributor in Tanzania economythrough export of its products, from

2002-2005 it contributed about 60% of foreign exchange, it also accounts about 45% of

gross domestic product in Tanzania economy.

Despite huge effort by the government and agriculturalist still agriculture has low

productivity; this low productivity is attributed by erratic rainfall in different time and

places, sometime low rainfall experience leads to drought, high rainfall leads to

14

2.3.0 Coffee production trend and development since independence

Coffee production by 1980 was almost low about 761,000 bags of coffee were produced

and increasing sharply by 1981 to 1,060,000 bags of coffee. And it declined to 796,000

bags by 1985 and it rose to 962,000 bags by 1989. Production declined by 1991 to

763,000 bags and then rose up to 992,000 bags by 1993, it declined to 680,000 bags by

1995 and then it increased to 1,070,000 bags by 2005 and sharply declined by 2006 to

610,000 bags, it rose up to 1,150,000 bags by 2009 and was sharply decline by 2010 to

610,000 bags which marked the lowest production ever since 1980(Indexmundi,2013).

Consider coffee production trend from 1980-2010 in table 2 below;

2.3.1 Factors that influence coffee production in Tanzania

Production of coffee in Tanzania faces various difficulties (challenges); Poor

implementation, monitoring and evaluation of projects and activities in key programs

especially on agricultural programs and projects, repeated bad weather such as rain

vagaries together with technological backwardness.

15

CHAPTER THREE

LITERATURE REVIEW

3.0 Introduction

This chapter describeshow different literatures explain relationship that exists on inflation

and production especially agricultural production and how does inflation affect

production. The section comprises two sections in section one it presents theoretical

literature review and in section two of the chapter present empirical literature review.

3.1 Theoretical literature review

According to Tobin (1965), inflation is beneficial to output growth since it lower interest

rate, and therefore opportunity cost to invest, as this increase the capital-labor -ratio and

therefore increase output, therefore according to Tobin inflation is motivation to investors

through increasing profit to their business.

Inflation, since it lowers purchasing power of the currency it then have negative impact

and correlation to output growth, inflation ruin output growth, since as inflation increases

it decreases capital stock. In turn this leads lower capital stock power to investors

therefore reduces productivity in the economy. This is suggested by Stockman (1981)

Gylfason and Herbetsson (2001), they proposed inserting money balance into money

function, as proxy of the financial depth on production and they found negative

relationship between inflation and growth through the following; lowering of interest rate

and hence saving rate and level of saving, it reduces efficiency by driving wage between

the return to real and financial capital, and finally lower financial depth and in turn output

production in the economy.

Paal and Smith (2001), argued that, the relationship between money growth and real

growth is characterized by threshold, at low growth rate of money, banks perceive small

opportunity cost in detaining reserves instead of lending fund for investment and growth.

16

When interest grows beyond threshold level, then credit rationing badly affects lending,

reducing capital and accumulation. Due to reduced capital and low accumulation this

lowers productivity and production (growth). This suggests negative correlation between

inflation and growth of output.

According to Keynesian theory, which combine aggregate demand (AD) and aggregate

supply (AS), the theory has in details explain the relationship between inflation ad output

growth, the theory suggests negative short run relationship between inflation and output,

but not the case in the long run, meaning no permanent tradeoff this is according to

Keynesian theory, Dornbusch (1996).

This is due to the fact that, aggregate supply in the short run slope up ward than vertical

and hence any change of aggregate demand shall effect output and price in the economy,

this hold when any factor that drive inflation and output have short run effect and not

long run effect.

M Keynes argues that inflation fluctuates value of currency and hence distorts

relationship between creditors and debtors, this distortion accommodate low growth

through low investment to low production.

Milton Friedman the monetarist argue that inflation is monetary phenomenon resulting

from higher supply of money than the rate of economic growth (production), this pull up

price level through creating higher demand than supply in the economy. Therefore due to

Friedman’s explanation inflation and output production has negative relationship in the

economy.

Inflation hurts production (growth) in the economy since it increase cost of production

(inputs) such as wages, raw materials and hence may reduce capacity of production

(Atmand, 2007). Inflation may be caused by action of government to print too much

money which in turn is less to the economic level of the economy (Mankiw, 4th

edition)

17

Despite various proposed concerning inflation and growth relationship, but inflation has

negative and harmful to growth, except for low inflation rate has positive relationship,

even though literature theories cannot tell how much each influence the other.

3.2 Empirical literature review

P. S Saunders (1996) realized negative impact of inflation toward agricultural

productivity, higher inflation reduces productivity of agriculture and hence production.

High inflation rises up the cost of agro-equipment and agro-chemicals and hence reduces

productivity in the sector. The study employed VAR model for econometric analysis.

United states of America by 1973 experience fall in production of agricultural

production, this was attributed by high oil price, this suggest the contention that inflation

has adverse effect on agricultural production especially crop production in any economy

(D. G. Jonson, 1980). Therefore inflation such harmful thing to agricultural production, it

then therefore have to be controlled.

High inflation and more inflation uncertainty motivates low productivity hence output

growth, therefore according to Stilianos et al (2001) suggest measures that leads to stable

price level should be encouraged in order that output production is boosted up. When

inflation is increasing and there are uncertainty predictions on its trend then producers

become less confident on their production and hence they cut production to solve such

uncertainty.

According to Kim and Willet (2000), they found that inflation rate tend to harm

production hence higher production is characterized with low to moderate inflation while

higher inflation result to low production in the economy. Unlike developed countries

which less affected by inflation, developing countries should have strategic plans to

control inflation as they highly affected.

18

Bullad (1999) and Temple (2000) they found that inflation has no relation in the long run

but only in the short run. And they based on unit root testing. In short run increase in

inflation affect negatively but in long run an increase or decrease in inflation has no any

impact to output production. Therefore inflation control should be to reduce inflation to

steady state that motivate producer through increasing profit.

Gylfason and Herbertsson (2001) found no linear relationship between inflation and

growth in which they found inflation from 5% to 50% lead to declining in real growth

rate. They found this nonlinear relation hold that inflation below 10% has positive

relation with real growth rate but above 10% has negative relation with output.

Chari et al (1996), inflation and real growth has negative relation where an increase in

inflation rate from 10% to 20% lead to decrease in growth by 0.2% to 0.7%, hence

inflation should be controlled since it harm growth. Therefore single digit inflation is at

least suitable for output growth in the economy.

Arai et al, (2004) found no relation between inflation and growth through the use of panel

data for 115 countries over the period from 1960-1995 so they conclude inflation is not

harmful to growth in the economy, it is therefore no need to control inflation to protect

output production in the economy.

IMF staff papers 1960, experience no relationship between inflation and production it

specify Latin America by 1950s and 1960s their inflation rate were in double digit but

still growth was respectable, there fore inflation and growth has no relation in the

economy.

In 1993 Fischer found inverse relationship between inflation and growth in his study

“The role of macroeconomic factor in economic growth”. According to Fischer higher

inflation rate associates with low production and low inflation associates with increasing

growth.

19

A study by M. Bruno and W. Easterly in 1996, they found positive short run relationship

between inflation and growth, also they found long run inverse relationship between

inflation and growth. In short run increase in inflation motivate producers through

increasing profit, while in long run it is harmful to producers since it affect input price

hence rising cost of production.

Any policy that protect agriculture sector from effects of inflation in long run and short

run they should be encouraged as they will lead to sustainable increasing agricultural

production (Mesike et al 2010). There fore policies that defend agro-chemicals and agro-

equipments from higher price reduces agricultural cost of production and hence higher

agricultural production.

Inflation and output growth has weakly correlation while the change in output gap bears

significant bearing to the case of Fiji-Brazil, (Hanif, 2004). Inflation increase has

littleimpact to output growth.

In a study conducted in Iran shows that monetary policy reform has significant impact on

food prices and domestic agricultural production, the reason is that these policies has

implication on consumption pattern and have serious implication on agricultural

production (Shahnoush et al, 2009).

Despite various proposed concerning inflation and growth relationship, but inflation has

negative and is harmful to growth, except for low inflation rate has positive relation, even

though literature theories cannot tell to how much each influence the other. There is a

need to conduct an empirical study in case of Tanzania.

20

CHAPTER FOUR

METHODOLOGY

4.0Introduction

This study investigate impact of inflation on agricultural production especially crop

production specifically on coffee production Tanzania from 1980 – 2010. In this study

time series data is used.

Two variables are used in this study inflation (π) and coffee output (Y), they are analyzed

in terms of their percentage to come up with their relation in econometric modeling.4.1

Testable hypothesis

This study is going to test two variables; inflation rate and coffee output growth rate

using Co integration and Error Correction Model.

Hypothesis that are going to be tested;

Null Hypothesis (HO): Inflation has negative impact on coffee out put growth

Alternative Hypothesis (HI): Inflation no impact on inflation

4.2 Model specification

This study aim to find the influence (impact) of inflation on growth of agricultural output

especially in long run, the study shall employ co integration to examine long term

relationship between inflation and coffee production since 1980 to 2010, it is almost

thirty one years (31 years).

According to Engle-Glenger (1987) two stepused to examine co integration among

variables in time series data using the following co integration regression;

Yt= β1 + β2πt + εt ………………… (i)

21

This regression is known as co integrating regression showing long-term equilibrium or

relationship between the two variables and it can be expressed as;

εt = Yt – β1 – β2πt ………………………….(ii)

Where;

Yt– Output (Annual Coffee production)

β2– Co integrating parameter

β’s – Parameters

πt – Inflation at time t

ε – Error term.

4.3 Measuring inflation

Inflation can be measure in various ways, whose one way is through Consumer Price

Index (CPI), consumer price index measure changes of price of common basket goods

and services such as food, clothes, gasoline, building materials. In Tanzania these data

are compiled by the National Bureau of Statistics (NBS), they are compiled on basis of

monthly and annual data.

There also is Producer Price Index (PPI), measures the selling price change that producer

is able to get for a goods or services. National Bureau of Statistics (NBS) also compiles

this.

22

Gross National Product (GNP) deflator, which measure the price changes of all final

goods and services produced in the economy.

Typically there are two types of inflation; Demand pull inflation, this occur when demand

of goods and services exceed the supply of goods and services and cost push inflation

occur when cost of production is rising leads to increase in general price in the economy.

4.4Estimation procedure

This study aim to investigate impact of inflation on crop production, specifically coffee

production in Tanzania. Study shall is using time series data

4.4.1 Unit root test

Time series data normally tend to have unit root problem that is they are not stationary.

Using data with unit root problem may bring spurious results in data analysis. To avoid

spurious results and inaccurate analysis we test for unit root using Augmented-Dickey

Fuller test.

When unit root is detected then we correct it so that data to become stationary and then

we run co integration among variables using Johansen Co integration to estimate long run

relationship among variables.

4.4.2 Error Correction model

Since co integration shows only long run relationship among variables but cannot show

short run relationship we may correct this di equilibrium using Error Correction

Mechanism.

Co integration shows only long-run relationship among variables but do not explain

short-run equilibrium since may appear.

23

Therefore error term from regression equation (i) as equilibrium errorand using such error

term to describe the short run behavior of output (Yt). Error Correction by Engle and

Glenger can correct this equilibrium when two variables are co integreted, this is shown

as;

ΔYt = βo + β1πt + β2μt-1 +εt……………(iii)

Where;

Δ- First difference operator

β2- I s a parameter that describe to what extent or how quickly shall output Yt restore to

the equilibrium

μt-1 = Yt – β1 – β2πt –One period lagged value of error term from the co integrating

regression equation (i)

Therefore this error correction mechanism (ECM) shows that output Yt depend on

inflation πt and dis equilibrium error term μt-1 = Yt – β1 – β2πt

4.5 Data type and source

This study use time series data in its analysis, it uses secondary data from various sources

such as Bank of Tanzania, websites such as www.indexmundi.comand other documents

from various sources.

http://www.indexmundi.com/

24

CHAPTER FIVE

EMPIRIC RESULTS AND THEIR INTERPRETATION

5.0 Introduction

This chapter presents and discusses empirical findings and analysis of the study. The

chapter presents the following statistical properties of data, correlation analysis among

the variables, test for unit root, test for co integration, error correction mechanism

(ECM), empirics of study, comparison of the study with past studies, measures taken by

the government to control inflation in Tanzania, other factors than inflation that influence

coffee production in Tanzania.

5.1 Statistical properties of data

The statistical properties of data, the data follows normal distribution

Table 3 Statistical properties of data

COFFEE INFLATION

Mean 2.635161 19.53871

Median -5.580000 21.80000

Maximum 74.84000 36.10000

Minimum -47.83000 4.700000

Std. Dev. 28.67824 11.43170

Skewness 0.590960 -0.072499

Kurtosis 2.920823 1.382217

Jarque-Bera 1.812473 3.407733

Probability 0.404042 0.181979

Observations 31 31

25

5.1.1 Correlation analysis between inflation and coffee growth rate

Correlation analysis tends to look relationship among the variables, that is to how much

and to what direction does each variable influence the other. This study shows there is

negative association (correlation) between inflation and coffee production. Consider the

following

Table 4 Correlation table

Variable Inflation Coffee

Inflation 1.00000 -0.128219

Coffee -0.128219 1.0000

5.1.2 Test for unit root (Stationary of data)

Augmented-Dickefuller test for unit root shows that;

At level;

Table 5 Unit root test table

Variable ADF test No of lag State

Inflation -.0991895 0 Non stationary

Coffee -11.98026 0 Stationary

Statistics shows inflation is not stationary at level while coffee is stationary. To avoid

spurious results we should run the first difference for inflation to make it stationary.

In first difference

Table 6 Unit root test in 1st difference

Variable ADF test No. of lags Difference State

Inflation -6.026872 1 I(0) Stationary

Inflation becomes stationary in first difference.

26

5.1.3 Test for cointegration

Co integration measures the long-run relationship among variables. The test shows there

is a long-run relationship show there is long-run relationship among variables. This

relationship has shown at 5% significance level.

Table 7 Co integration table

Likelihood 5 Percent 1 Percent Hypothesized

Eigenvalue Ratio Critical Value Critical Value No. of CE(s)

0.863690 82.10330 15.41 20.04 None **

0.567565 24.31138 3.76 6.65 At most 1 **

*(**) denotes rejection of the hypothesis at 5%(1%) significance level

L.R. test indicates 2 cointegrating equation(s) at 5% significance level

5.2.1Error Correction Mechanism

Error Correction Mechanism (ECM) shows short-run and long-run relationship among

variables since co integration shows only long-run relationship. Statistics shows that -

1.795% of coffee deviation from long-term equilibrium adjusted annually.

Statistics shows there is significant long-run relationship since Probability value for the

error correction (RESID01(-1)) term is less than 0.05, but there is insignificant

relationship in the short run since probability value for coffee is greater than 0.05.

Table 8 Correction mechanism table

Variable Coefficient Std. Error t-Statistic Prob.

C 2.355227 3.836146 0.613956 0.5444

D(INFLATION) 0.381716 0.842063 0.453310 0.6539

RESID01(-1) -1.795716 0.145633 -12.33041 0.0000

27

Note: RESID01(-1) is Error Correction Term (ECT)

5.2.2 Empirics of study

The study shows that inflation has negative impact to coffee production, rise of inflation

reduce coffee production, though this the study shows this impact is insignificant which

shows that inflation is either not good indicator to influence coffee production in

Tanzania.

Table 9 Regression results table


C 8.919932 6.138455 1.453123 0.1569

INFLATION -0.321657 0.241665 -1.331006 0.1936

The results shows inflation is insignificant, this true and shows inflation only cannot

explain inflation on its own there are other variables that explain coffee production which

are discussed in section 5.4.

Though the truth is that inflation affect coffee production in the long run but in short run

significant impact of inflation to coffee output this is just because of the reason that once

coffee is grown and on harvest stage inflation cannot affect yield since it has already

grew. But in the long run inflation has an ability to reduce coffee production as it

influence cost of agro equips, agrochemicals, cost of transport, cost of labor and other

costs relating to coffee production.

5.3 Measures taken by the government to control inflation in Tanzania;

The Bank of Tanzania has termed inflation as nation’s “Economic enemy number one”.

To control inflation the bank managesthe growth of money supply especially broad

money supply two (M2) which comprise currency in circulation (CC) and demand

deposit (DD) since they have direct relationship with money supply.

28

Bank of Tanzania uses monetary policy to influence economic behavior in the economy;

Open market operation, foreign market operation (FEMO), Standing facilities (Lombard

and discount window), Repurchase agreement transaction, statutory reserve, requirement

and moral sasuation.

Also Bank of Tanzania does the following to fight against inflation; Refinancing policy,

minimum reserve policy, open market policy. And at the beginning of each fiscal year the

Bank of Tanzania set the annual monetary policy to direct the economy toward

prosperous economy. Economic and financial reforms from 1980s in Tanzania were also

aiming at reducing inflation for prosperous economy.

5.4 Other factors than inflation that influence coffee production in Tanzania

Poor implementation, monitoring and evaluation of projects and activities in the key

programs make coffee production having less progress, and climatic vagaries such as

long drought or very high rainfall distort certainty of coffee production.

Technological backwardness, example drying technology of the coffee, since poor drying

results to less quality coffee which in turn has adverse effect in the coffee market.

Inputs of production, combination of inputs such as fertilizers, agro equips have great

influence in coffee production, insufficient use of these inputs such as chemicals and

fertilizers together with poor quality inputs are adversely affect production of coffee in

Tanzania.

Intensity of intercropping, most of coffee farms have been intercropped with banana

trees, banana trees reduce the process of photosynthesis which help much in food

generating to coffee trees, banana trees shadow the coffee leaves from trapping sunrise

for photosynthesis, hence poor coffee production due to less food generated for coffee,

most of coffee trees are old hence provide out low yield hence due to these features

coffee production become less productive.

29

Replanting of trees since most trees are old ones by, replanting of trees reduces

production for a given period of time, example study by world bank (2003) shows there

were about 1348 trees were planted, since replanting involve uprooting therefore till time

to harvest take some times hence fluctuates coffee output.

Age of coffee trees, economically coffee tree is unprofitable when it passes 20-25 years

but in Tanzania most of trees has passed this age, according to Friedrich Erbert Stiftung

(2004) shows most of 240 million trees have passed this age limit therefore coffee age

influence productivity of coffee in Tanzania.

Price of coffee, in Tanzania coffee farmers may receive less than 50%(Mhandoetal, 2010)

of auction this makes coffee production unprofitable to farmers, this influence farmers to

opt much effort to other economic activities than coffee production.

These factors have greater influence on coffee production than inflation rate in the

economy; this is why regression results shows inflation is insignificant to explain coffee

production in Tanzania.

30

CHAPTER SIX

CONCLUSION, POLICY IMPLICATION AND RECOMMENDATIONS

6.1 Main findings

Main objective of the study is to investigate impact of inflation on agricultural production

specifically on coffee production in Tanzania. From observation and analysis the study

found that there is negative relationship between inflation and agricultural production.

The study shows there is long run relationship between inflation and agricultural

production, but there is no short run relationship between the two variables.

But this relationship between inflation and agricultural production is insignificant

indicating that inflation is either not good indicator to influence crop production in

Tanzania.

In this study the study found that inflation only is weak to affect agricultural production,

there other factor which are strongly impact agricultural production especially coffee

production than inflation, these factors may either include age of coffee tree, technology

employed in production, replanting of coffee trees to replace the older ones and intensity

of intercropping.

6.2 Policy implication and recommendations

From the study, since there is long run negative relationship between inflation and

agricultural production though is insignificant but the government should concentrate on

ensuring long run economic stability in the economy especially through monetary policy.

The government should also educate farmers on modern techniques of coffee production.

All projects should be effectively evaluated and implemented timely so that all activities

are conducted in sequential order for the development of agriculture and Tanzania’s

economy, since agriculture employ majority of Tanzania.

31

6.3Limitation of the study and recommendation

The study has undergone much limitation especially on quality and consistent data

collection; in this study only one variable that is inflation has involved in estimation of

the data leaving other variables untested such as; age of coffee trees, climatic change,

price of coffee in local international market which other study in future may incorporate

them in studies.

32

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and further semi parametric evidence.” University of Verona and Institute for the world

economy.

Bank of Tanzania. (2011). “Tanzania mainland’s 50 years of independence: A review of

the role and function of Bank of Tanzania.”

P. J. Saunders. (1996). “A time series analysis of the relationship between inflation and

productivity growth in the U.S agricultural sector.”

C.S. Mwsike, R.N. Onike and O. E Inoni.(2010). “Impact of inflation and government

agricultural policies on relative price variability of cash crops in Nigeria.”

United Republic Of Tanzania. (2008). “Agricultural sector review and public sector

review 2008/2009.” Ministry of Agriculture, Food security and cooperatives.

United Republic of Tanzania.(2012). “National Sample Census of Agriculture small

holder agriculture.” Volume II: Crop sector-National report.

United Republic of Tanzania.(2012). “Tanzania coffee industry.Development strategy

2011/2021.”Amended version.

United Republic of Tanzania.“Creating enabling agricultural policy environment.”

Sokoine University of Agriculture.(2005). “Coffee base line report.”Tanzania coffee

research institute.

A.A.L. Kilindo. (1997). “Fiscal operations, money supply and inflation

Tanzania.”African research consortium.

33

J.B. Mwakalikamo. (2011). “Public budget deficit.Factors for it and its impact on

macroeconomic variables (Inflation, trade deficit and exchange rate).

N. Shahnoush, S. Hennebery and H. Mansori. (2009). “An examination of the

relationship between food prices and government monetary policies in Iran.”

Araij, Mahmood, Mats Kinnwall and Thoursie, Peter, Skogman.(2004). “Cyclic and

causal pattern of inflation and GDP growth.”Applied economics.

Bullard, James. (1999). “Testing long-run monetary neutrality propositions: Lesson from

recent research.”Federal bank of St. Louis review.

Gylfson, Thorvaldul and Tryggvi T. Herbertsson.(2001). “Does inflation matter for

growth? Japan and the world economy.”

Kim, Sung and D. Willet.(2001). “Threshold effect in the relationship between inflation

and growth.”IMF staff papers.

Paal, Beatrix and Bruce Smith.(2001). The sub optimality of the Fieldman Rule and

optimum quantinty of money.” IEHAS discussion paper 0113, Institute of economics,

Hungarian Academy of Sciences, Budapest.

Stockman, Alan C. (1981).Anticipated inflation and the capital stock in cash-in-advance

economy.”Journal of Monetary Economics 8.

Temple, Jonathan. (2000). “Inflation and growth: Stories short and tall”. Journal of

Economics survey 14.

Tobin, James. (1965). “Money and Economic growth.”Econometrica 33.

34

Atmanand.(2007). “Managerial Economics.” Excel books private limited, New Delhi.

MBA first year, paper No. 2.

D.N. Gujarat. (2004). “Basic Econometrics.”Fourth edition, The McGraw-Hill

Companies.

N.G. Mankiw. “Principles of microeconomics.”4th

Edition.

R. Dornbusch, S. Fischer and Kearney. (1996). “Macro Economics.”The Mc-Grow-Hill

Companies, Inc. Sydney.

W.H. Greene. (2002). “Econometric analysis”.5th

Edition.

African Development Bank. (2011). “Inflation dynamics in selected East African

countries:” Ethiopia, Kenya, Tanzania and Uganda.

V. Gokal and S. Hanif. (2004). “Relationship between inflation and economic growth.”

Reserve bank of Fiji,Working paper 2004/04.

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Http://explorable .“com/null-hypothesis.html”. 7th

January, 2013.

http://explorable/

35

APPENDICES

Appendix 1 Regression results

Dependent Variable: COFFEE

Method: Least Squares

Date: 05/22/13 Time: 13:01

Sample: 1980 2010

Included observations: 31

Newey-West HAC Standard Errors & Covariance (lag truncation=3)


C 8.919932 6.138455 1.453123 0.1569

INFLATION -0.321657 0.241665 -1.331006 0.1936

R-squared 0.016440 Mean dependent var 2.635161

Adjusted R-squared -0.017476 S.D. dependent var 28.67824

S.E. of regression 28.92774 Akaike info criterion 9.629820

Sum squared resid 24267.62 Schwarz criterion 9.722335

Log likelihood -147.2622 F-statistic 0.484731

Durbin-Watson stat 3.208000 Prob(F-statistic) 0.491830

36

Appendix 2 at level Unit root test

ADF Test Statistic -0.991895

1% Critical Value* -3.6661

5% Critical Value -2.9627


*MacKinnon critical values for rejection of hypothesis of a unit root.

Augmented Dickey-Fuller Test Equation

Dependent Variable: D(INFLATION)


Date: 05/21/13 Time: 19:25

Sample(adjusted): 1981 2010

Included observations: 30 after adjusting endpoints


INFLATION(-1) -0.075843 0.076463 -0.991895 0.3297

C 0.715598 1.750129 0.408883 0.6857

R-squared 0.033945 Mean dependent var -0.800000

Adjusted R-squared -0.000557 S.D. dependent var 4.672738





Coffee

ADF Test Statistic -11.98026 1% Critical Value* -3.6661


37




Dependent Variable: D(COFFEE)


Date: 05/21/13 Time: 19:40




COFFEE(-1) -1.727141 0.144166 -11.98026 0.0000

C 6.228976 3.956970 1.574178 0.1267


Adjusted R-squared 0.830930 S.D. dependent var 52.05352





Appendix unit root test at first difference





38



Dependent Variable: D(INFLATION,2)


Date: 05/21/13 Time: 19:48




D(INFLATION(-1)) -1.157648 0.192081 -6.026872 0.0000

C -0.770808 0.886412 -0.869582 0.3922







39

Granger causality test

Appendix 3Co integration test

Date: 05/22/13 Time: 07:52

Sample: 1980 2010

Included observations: 29

Test assumption: Linear deterministic trend in the data

Series: COFFEE DINFLATION

Lags interval: No lags

Likelihood 5 Percent 1 Percent Hypothesized

Eigenvalue Ratio Critical Value Critical Value No. of CE(s)

0.863690 82.10330 15.41 20.04 None **

0.567565 24.31138 3.76 6.65 At most 1 **

*(**) denotes rejection of the hypothesis at 5%(1%) significance level

L.R. test indicates 2 co-integrating equation(s) at 5% significance level

Unnormalized Co-integrating Coefficients:

COFFEE DINFLATION

0.006760 -0.000443

0.001273 0.041243

Normalized Co-integrating Coefficients: 1 Co-integrating Equation(s)

COFFEE DINFLATION C

1.000000 -0.065592 -4.886456

(0.45101)

40

Log likelihood -223.6198

Appendix4 Engle-granger co-integration test results.

Using the two steps AEG unit root test on residual the following results on the co-

integration among variables were obtained.







Dependent Variable: D(RESID01)


Date: 05/22/13 Time: 12:21



Variable Coefficient Std. Error t-Statistic Prob

RESID01(-1) -2.363139 0.388545 -6.082024 0.0000

D(RESID01(-1)) 0.246178 0.207085 1.188780 0.2453







41

Appendix 5 Error correction mechanism (ecm)

Dependent Variable: D(COFFEE)


Date: 05/22/13 Time: 13:16




C 2.355227 3.836146 0.613956 0.5444

D(INFLATION) 0.381716 0.842063 0.453310 0.6539

RESID01(-1) -1.795716 0.145633 -12.33041 0.0000







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