A Study on Co-integrating Relationship between Inflation and its Determinants in India

Abstract

In the global economic forum, India has been always at the highlight due to its changing inflation patterns. In fact, the inflation rate in India during the fiscal year 2007–2008 was so alarming that, even though India had experienced an average growth rate of more than 9%, the global financial crunch squeezed the economy so hard that a few sectors experienced a slump. Though a number of research studies could be found related to inflation and its determinants in case of the European and Asian economies, but, in context of India, not many studies can be found in the literature. Against this backdrop, this paper seeks to empirically analyze some of the major determinants of inflation in India, by considering the newly constructed three Consumer Price Indices (CPI) inflation and a set of macroeconomic variables, namely, Gross Domestic Product (GDP), Index of Industrial Production (IIP), Broad Money (M3), Narrow Money (M1), Export (EXP), Import (IMP), Oil Export (Oil EXP), Oil Imports (Oil IMP), Gross Fiscal Deficit (GFD), and Foreign Exchange Reserves (FOREX). Time series data has been analyzed using ADF Unit root test, Granger Causality test, and Johansen Cointegration Test and Vector Error Correction Model. It was also found that CPI (Rural) is found to have bidirectional granger causality with the three macro variables i.e. IIP, Export and Import. Besides, CPI (Combined) is found to make short-run adjustment with changes in GDP, IIP, M3, Oil Imports and Oil Export products. GDP and IIP, no doubt, are used as measure of economic growth of a country by most of the researchers. The short-run relationship is supported by researchers like Patnaik (2010; p. 118–129), and Sehrawat and Giri (2015; pp. 1–08).