The nature of the relationship between the money supply and inflation in the Jordanian economy (1980–2019)

Abstract

This study aims to investigate the relationship between the money supply (M1) and inflation in the Jordanian economy during the period of 1980–2019.To achieve the goal of the study, the methodology of econometric analysis of time series was used through the following tests: Augmented Dickey-Fuller (ADF) test – to test the stability of the study variables, Johansen’s Cointegration Approach – to determine the long-term equilibrium relationship between the study variables, and the Granger Causality Test – to determine the direction of the causal relationship if it exists in the short term.The study results demonstrate that inflation has stabilized at the level, while the money supply M1 was unstable at the level and stabilized after taking the first difference. The Cointegration test results indicated that there was no causal link between the money supply M1 and inflation in the long term. Finally, the results of Granger Causality presented a unidirectional causality running from the money supply M1 to inflation in the short term, meaning that money supply causes inflation, not vice versa; this means that the money supply M1 can explain the changes that occur in the consumer price index (CPI) in the Jordanian economy.The study recommends that the monetary authority in Jordan should have greater control over the money supply due to its impact on the stability of the general level of prices, in order to avoid a repeat of the 1989 crisis represented by the sharp decline of the dinar exchange rate against other currencies and an increase in inflation that year to 25.6%.