Modelling Inflation in Lesotho : A Cointegration Analysis

The paper analyses the dynamics of inflation in Lesotho using the cointegration and error-correction techniques for the period 1980-2010. The results indicate that inflation inertia, output gap and the South African prices have been the main determinants of the long-run inflation process in Lesotho while money supply, nominal exchange rate and government spending appear to have no significant effect. The observed high degree of inflation persistence could be a reflection of backward-looking adjustments in wages and gradual adjustments in administered prices and subsidies within the country. Furthermore, the results reveal that inflation in Lesotho has experienced significant fluctuations in the short-run due to some policy changes as well as exogenous shocks. However, given that the country operates under a fixed exchange rate regime, fiscal policy remains the major instrument for maintaining macroeconomic stability and as a result, the appropriate balance between price stability and economic growth could be attained through a closer coordination between monetary and fiscal policies.