Sensitivity to Key Parameters of Short Run Simulation Results of Terms of Trade Shocks in a Kenyan CGE Model

Abstract

This paper presents results from a CGE model where the twin terms of trade shocks that the Kenyan economy faced in the 1970s have been considered. The paper addresses the question of the robustness of the simulation results from these shocks through sensitivity analysis of key parameters in the model, namely the trade elasticities and the wage indexation parameter. The paper shows that the extent to which Kenya as a primary commodity exporting country suffers from the 'Dutch disease' depends to an extent on the responsiveness of its primary exports to relative price changes in the export supply function. The higher the levels of elasticities of transformation the more pronounced is the extent of the 'Dutch disease' phenomenon resulting from a booming agricultural sector. Moreover, the simulation results of the terms of trade shock were found to be extremely robust with regard to different values of Armington elasticities. Lastly, the paper shows the importance of a wage indexation parameter that closely reflects the institutional arrangements under which wages are formed. a parameter that fixes money wages resulted in expansionary and less inflationary external shock. These results significantly differ from the outcome of the external shocks in case the real wages are fixed instead