Marginal propensity to import and terms of trade: Panel granger causality evidence from the East African Community (EAC)

Abstract

Abstract Subject and purpose of work The nexus between the terms of trade and marginal propensity to import and the consequent policy options arising from it among economic blocs is an area that has not been given due attention in the literature. The focus of the current paper is to examine the link between the marginal propensity to import and the terms of trade in the East African Community (EAC). Material and methods The authors discuss and test a panel Granger causality model which is complemented with the test of impulse response function and variance decomposition using data from five EAC countries (Uganda, Tanzania, Rwanda, Kenya and Burundi). Results The long-run result of the study indicated that causality runs from all the variables to the terms of trade. In the short-run, results reveal that both the marginal propensity to import and the export of manufactures Grangercaused terms of trade without a feedback. The results of the impulse response function revealed that the terms of trade responded positively to shocks in the marginal propensity to import only in the first period, but afterwards the response turned negative in all the other periods. The terms of trade were equally found to respond positively to shocks in inflation rate in all the periods. The variance decomposition results indicated that apart from shocks to itself which was 100% in the first period, marginal propensity to import contributed about 0.0458% of shocks to the terms of trade, and this rose continuously in all the periods. Conclusions The analysis shows that both in the long-run and the short-run, marginal propensity to import determines the terms of trade among the EAC countries.