Uncovering the roots of Nepalese inflation: An empirical investigation

Abstract

Nepal's reliance on imports and its vulnerable position to external economic shocks, understanding the factors that drive inflation is especially important in order to ensure stability and competitiveness in the country's economy. This research aims to explore the factors that influence inflation in Nepal over the period from 2000 to 2021. To do so, we analyzed the relationship between the current account, government expenditure, money supply, and inflation using empirical methods and statistical techniques such as the OLS method and ADF test for stationarity, as well as static forecasting and a VAR model. We hypothesized that a deficit in the current account, high levels of government expenditure, and an increase in the money supply may contribute to higher domestic inflation. Our analysis revealed that there was high multicollinearity and non-stationary time series data, but the regression model had satisfactory predictive power. Additionally, we found that an exogenous shock to inflation had an immediate effect on government expenditure, current account, and money supply, and there was a unidirectional causality between inflation and money supply. These findings can help policymakers make informed economic decisions to minimize negative impacts on Nepal's economy.