An Empirical Study of Inflation in Bangladesh

Abstract

This is an empirical study on inflation in Bangladesh. This study examines the relative importance of demand-pull, and cost-push factors explaining inflation in Bangladesh, investigates causal relationships among inflation and some of its determinants, and studies impact of inflation on GDP growth over the period 1976-2013 through empirical analysis. The results show that money supply, real income, inflation expectation, and real rate of interest are the key demand-pull determinants of inflation. The estimates of sub-periods demonstrate that money elasticity of inflation is higher during pre-liberalization period (1976-1990) than the post-liberalization period (1991-2013), but the fully reverse results are found in case of interest elasticity of inflation. The cost-push model gives evidence that the nominal wage and exchange rate are important determinants of inflation. The ARDL-VEC models show that in the long-run, inflation in Bangladesh is influenced by the money supply growth, real income growth, real interest rate, and import price growth, while in the short-run, it is mainly determined by the nominal wage, one year lag money supply, real income, and real rate of interest. The Granger causality test shows a unidirectional causality between money supply and inflation runs from money supply to inflation, while there is a bi-directional causality between wage and inflation that is the case of wage-price spiral in Bangladesh. The inflation is also found to affect GDP growth negatively in the long-run but not in the short-run. In addition, the Toda-Yamamoto causality test confirms a two-way causality between inflation and GDP growth in Bangladesh. The result of the IRF indicates that the responses of inflation to GDP growth are non-linear in nature. The CUSUM test suggests stability of the models in the study period for Bangladesh. To control inflation in Bangladesh, fiscal policy should be consistent with the targets of prudent monetary management.