Abstract
The purpose of this study is to determine the empirical relationship between budget deficits and inflation based on CPI, and to find empirical evidence of sources of inflation in Pakistan, considering data from 1973 to 2006. The main source of data has been the State Bank of Pakistan and the Federal Bureau of Statistics. Univariate analysis along with simple statistical analysis is utilized to determine the time series properties of each variable. Ordinary Least Square (OLS) method is used to analyze the relationship between the variables of Interest. Co-integration and Error Correction Mechanism (ECM) are used to determine the long run and short run relationships respectively. The results of this study indicate that there is a long run relationship between inflation and Budget Deficit to GDP Ratio (BDGR). Further sources of inflation in Pakistan have been budget deficits, GDP growth, and international inflation, reserve Money and weighted average lending rates. The implications are that tight monetary policy can serve as an effective anti-inflationary measure but a restrictive fiscal policy (reduction in government expenditures) can also help to minimize inflation in Pakistan.
Highlights
There has been a sharp increase in the level of prices for the last two years
Sustainability of high and persistent inflation rates are usually because of the following reasons: 1) High budget deficits 2) Monetization of budget deficits 3) Massive infrastructure investments by city, provincial and federal governments 4) High military expenditures associated with geopolitical reasons 5) Political instability which results in inflationary pressures 6) Persistent inflationary expectations of economic agents
Independent variables taken in this study are: Import Prices (IMPP), real GDP growth rate (GDPR) and Weighted Average Lending Rate (WALR)
Summary
There has been a sharp increase in the level of prices for the last two years (see Figure 1). 7) Inflationary effects of changes in exchange rates through increase in prices of imported inputs. 8) Occasional increases in world prices of major imported inputs (crude-oil). Rate of inflation has been more than 5%, except in 1983, 1986 and 1987 This persistent rise in general level of prices leads us to study the model and analyze the sources of inflation in Pakistan. What happens to the general level of prices when the fiscal deficits are created? The answer is inflation because deficits can be financed by increasing money supply. Hamberger and Zwick have concluded that higher federal deficits are inflationary while studying the USA data [2]; such relationship is being tested for Pakistan. Journal of Independent Studies and Research (JISR) - Management and Social Sciences & Economics
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