Abstract
This paper examines the dynamics of inflation in Sri Lanka using the cointegration approach on quarterly time series data. Considering recent empirical studies in the context of inflation in emerging countries including Sri Lanka, an empirical model has been constructed with seven variables; namely inflation, economic growth, government expenditure, exchange rate, money supply, oil prices and interest rates. The main determinants of inflation in Sri Lanka are the economic growth, exchange rate, government expenditure, money supply, oil prices and interest rates in the long run. According to the estimated impulse response functions, both domestic shocks (money supply, interest rate and economic growth) and external shocks (exchange rate and oil prices) have an effect on inflation in the short run. These findings would be useful for policy makers in their effort in maintaining price stability in Sri Lanka on a sustainable basis.
Highlights
This study reveals that money supply, exchange rate and GDP contain information which helps in exploring the behaviour of inflation in Sri Lanka
This study finds that money supply growth and the increases in rice price are the most influencing factors for inflation in Sri Lanka in the short run as well as in the long run, while GDP growth and exchange rate depreciation is not important
This paper reviews the impact on key macroeconomic determinants of the inflation in Sri Lanka covering the period of 2000–2013 for quarterly data
Summary
It can be defined as a sustained rise in the general level of prices i.e. a persistent rise in the price levels of commodities and services, leading to a fall in the currency’s purchasing power. Low inflation environment provides a better environment for economic growth, encourages investors, employment opportunities and higher living standards. Higher inflation causes adverse impacts on the economic performance of countries in many aspects and the identification of determinants of inflation is very important. According to Sahaduhhen (2012), unpredicted running and galloping inflation are regarded as unprecedented effects on an economy because they distort and disrupt the price mechanism, discourage investment and saving, adversely affect fixed income groups and creditors and leads to the breakdown of morals
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