Impact of macro economic determinants on inflation in Sri Lanka

Abstract

This study attempts to analyze the experience of inflation in Sri Lanka for the period 1960 to 2013 using the econometric framework of Johanson and Juselius cointegration approach, Granger causality analysis and vector error correction model (VECM). The data used are annual series of Colombo Consume Price Index as a proxy variable for inflation rate, gross national product, broad money supply, budget deficit and exchange rate. The empirical results of the study indicate the existence of long run dynamic relationships among the variables. However, VECM identified that broad money supply growth and exchange rate depreciation have significant positive effects on inflation. The errors of the VECM model was found as white noise. The results would be useful how business and industry play on the economy of the country. Furthermore, the results of this study emphasize the need to put in place a stable macroeconomic policy environment relating to these variables in an effort to maintain price stability, since low inflation would enhance economic growth.