Correlation and Causality between Inflation and Selected Macroeconomic Variables: Empirical Evidence from Pakistan (1990-2012)

Mehwish Nawaz,Salim Ullah Khan,Sami Ullah,Muhammad Naeem

doi:10.4236/ib.2017.94011

Abstract

Inflation is regarded as one of the most chronic problems in Pakistan and the recent surge of inflation (10.8) in consumer price index is a matter of serious concern in the economy [1]. Inflation imposes high cost on economies and societies; disproportionately hurts the poor and fixed income groups, creates uncertainty throughout the economy and undermines macroeconomic stability. It also results in inefficient resource allocation and hence reduces potential economic growth. High inflation has always penalized the poor. Lowering inflation therefore, directly benefits the low and fixed income groups. The present study focuses to examine the impact of various macroeconomic variables on inflation in Pakistan and to find their correlation and causal relationship with economic and econometric criterion by using time series data over the period of 1990 to 2012. To achieve this objective, regression analysis, correlation coefficient and granger causality test are used. Results from regression analysis indicate that money supply, government expenditure, government revenue, foreign direct investment and gross domestic product have positive impact on inflation in Pakistan, while interest rate shows negative impact. Correlation analysis confirms that there exists a positive association of inflation with money supply, government revenue, interest rate, foreign direct investment, gross domestic product, exchange rate and trade openness. The findings of the study also reveal that money supply as well as balance of trade granger causes inflation in the selected time period. I recommend that monetary and fiscal measures should be wisely coordinated in order to control the consistent increase in prices. The government should curtail expenditure and reduce money supply. Similarly, domestic production should be encouraged and trade deficit should be narrowed by increasing exports in the country.

Highlights

Stability of general price level is one of the key concerns of policy makers and any abrupt changes in it have always posed a serious threat for economic growth of any economy
The findings revealed that growth rate of Gross Domestic Product (GDP), money supply, imports, 1st lag of inflation and interest rate gave positive impression on inflation rate whereas other explanatory variables such as fiscal deficit and exchange rate were indirectly associated to inflation
Inflation is one of the most crucial problems in developing countries especially in Pakistan, different studies have been performed in several time periods on this issue

Summary

Introduction

Stability of general price level is one of the key concerns of policy makers and any abrupt changes in it have always posed a serious threat for economic growth of any economy. Unnecessary and abnormal increase in the general price level of goods and services reflects important repercussions for the economy. This elusive factor is called inflation and is defined as a continuous and persistent rise in the general price level in an economy whereas a percentage increase in the average level of prices over a year is called inflation rate [2]. Inflation is defined as the rise in prices of goods and services over time It is the most difficult and highly sensitive issue that policy makers and governments face. It affects almost everyone in an economy. It erodes the value of currency by reducing its purchasing power which means that a rupee can purchase fewer goods today than it did previously [3]

Objectives

Results

Conclusion