Estimating the causal relationship between external debt and inflation in Jordan: evidence from an ARDL and Toda–Yamamoto approaches

Abstract

Purpose This study aims to investigate the causal relationship between external debt and inflation in Jordan over the period 1970 to 2020. Design/methodology/approach The external debt–inflation nexus is examined within a multivariate framework by including other determinants of inflation, including money supply and the nominal effective exchange rate. This study uses an ARDL bounds testing approach to cointegration to test the existence of a long-run relationship between the inflation rate and its drivers. An error correction model is estimated to reveal the short-run dynamics of the series. The direction of causality among the variables is examined using a modified version of the Granger non-causality test due to Toda and Yamamoto (1995). The analyses control for the presence of structural breaks in the underlying time series. Findings The empirical results show that external debt and money supply have a statistically significant positive effect on inflation in the long run. The authors also find that a nominal depreciation of the Jordanian Dinar raises inflation rates in the long run. The Toda–Yamamoto Granger non-causality test findings reveal a statistically significant bi-directional positive causality between inflation and external debt, between the nominal effective exchange rate and inflation and between money supply and inflation. Practical implications Proper management of the exchange rate policy, money supply and external debt levels is crucial to control inflation rates in Jordan. Originality/value To date, the authors are unaware of any empirical study that examines the impact of external debt on inflation in Jordan, and the current study aims to fill this gap in the literature.