Inflation Threshold in the Context of Structural Breaks: Evidence from Egypt Using the Logistic Smooth Transition Regression Approach

Abstract

The disparities in structure and nature of developing economies, in terms of their level of development, yield mixed results on the linear/nonlinear relationship between inflation and real GDP (i.e., the inflation threshold), which should be revisited. No study examined the effects of inflation on real GDP in Egypt, particularly after the 2011 revolution and the November 2016 exchange rate floating. This study empirically investigates the inflation threshold in Egypt over the period 1976-2019. In other words, it seeks to determine the optimal level of an inflation rate such that beyond it, inflation becomes a destructive element to economic growth. To this end, the logistic smooth transition regression (LSTR) has been performed. Considering structural breaks, this study checked the stationarity of the variables with the Kapetanios unit root test. Results of the LSTR technique highlight a statistically significant positive relationship between inflation and GDP growth in the lower regime at 9.32%. Beyond this threshold, inflation harms GDP growth, indicating an asymmetric relationship between the two variables. Such a specified estimated inflation threshold could assist monetary authorities in setting their inflation target to be below that threshold. This study recommends that policymakers restrict inflation and keep it below the estimated threshold, considering that inflation in the Egyptian economy is derived from the aggregate supply, demand factors and the production apparatus's inelasticity.