Demand Driven Factors of Inflation in Sri Lanka: An ARDL Approach: 1977- 2019

Abstract

Inflation in Sri Lanka has been one of the major macroeconomic issues that the country has faced with, especially after 1977, because inflation in Sri Lanka is persistently high as it has indicated a double-digit figure. There are various factors contributing to this effect. The present study analyses the demand-driven factors of inflation in Sri Lanka because diverse theories were put forward by economists. Demand-Pull inflation is occurred when the aggregate demand (AD) exceeds aggregate supply (AS). There is an increase in  aggregate  demand  (AD)  categorised  through  four  sectors  of  the  economy  such  as  business, households,  foreign  buyers  and  government. To identify such factors, the time series data is used applying ARDL technique to identify the long-run and short-run relationships during 1977-2019 period. The demand-driven long-run factors are real GDP, fiscal deficit, treasury bills rate 91-days, and broad money supply. However, short-run factors are real GDP, imports, fiscal deficit, nominal wages -board, nominal wages – government and broad money supply. The findings would be useful for policy makers in their effort in controlling the inflation in the country by maintaining the price stability in Sri Lanka in a sustainable manner. The study found that increase in money in the economy will increase prices in the country in the short-run. Money supply indicated highest impact on the inflation. Thus, due to higher growth in money supply investments opportunities will tend to go up and more employment opportunities will be generated in the country. This will cause the aggregate demand to rise causing the domestic prices of goods and services to go up due to higher demand. These results clearly show that money supply impacts the inflation through demand side.

Keywords: Inflation, ARDL, Co-Integration, Money Supply, Fiscal Deficit, Central Bank, Monetary Policy