Inflation and economic growth

Inflation and economic branchThis section of the paper provides literary evidence on the relationship of pomposity in the economic ontogenesis and helps in the understanding of any causal relation amid them, if there exists any. We start with the conclusive evidence provided by minute of arc Li (of the University of Alberta). We kindle this support from the interrogation conducted by Li on the Inflation Threshold Effects in the Finance-Growth Nexus and Transmission Mechanism Analysis. During the course of this interrogation, the author examined the relationship betwixt the pompousness and the finance and economic growth, utilizing data collected from 90 countries. The authors query finds evidence of the organism of a nonlinear effectuate of the rising prices the relation amidst finance and growth. The research as puff up finds that though finance may stimulate growth at low pomposity, however, the relationship does non hold beyond the threshold of 15% for pompous ness. The main features of this research includes the implication that the adverse effect rising prices has on economic growth during a achievement of high pompousness toilet altogether be hold upled by improving the course of actions of only financial intermediaries (Li M. , 2007)The findings of the research show a strong positive and a significant relationship among finance and growth. However, as far as the effect of largeness on this relationship is concerned, there is little accord, and a threshold is agreed to be an brisk component in the opening. This implies that as the inflation rises supra a certain threshold take aim, which is estimated to lie between 14-16 %, the positive finance-growth relation weakens. The research also implies that the apostrophize of inflation can be be said to have been derive by the management capabilities of financial intermediaries with regard to accumulated bully. The paper examines the productivity of capital in a high-inflation e nvironment, concluding with the findings, which provide evidence on the existence of a robust non-linear relationship between inflation and the productivity of capital, and also identifying it as a causal relationship in a way that inflation has adverse cause on the productivity of capital. (Li M. , 2007)In an new(prenominal) research, in which Li talks about a general agreement among economists upon the problems ca employ by inflation, an examination of relationship between inflation and economic performance has been brought into play. in contrast to the other research that, examines the adverse effects of inflation on the capital productivity, the author attempted to shift the focus to economic performance and its relationship with inflation. This research, Inflation and sparing Growth is collected from a data of 90 countries that atomic number 18 developing and 28 developed countries besides them, over the period of 1961-2004 in order to extract relevant evidence on the targe t relationship analysis. According to Li, in this research, the evidence provided buy the research findings supports the concept of the existence of a non-linear relationship between inflation and economic growth, non unlike capital productivity. (Li M. , 2006)However, a detailed matter revealed that this extend varies between developed and developing countries in damage of nonlinearity in the proposed variable relationship. The findings of the research lead to shaping of important phenomena pertaining to relationship between inflation and performance. Li claims that at lower than first threshold, of the two identified, level of inflation, the effects of inflation on growth are not significant and are positive. at mode crop roam, between the two levels the effect is significant and disconfirming and above the second threshold the marginal match of additional inflation vanished from the growth but the relationship is still set in motion to be negative. This can only be said f or the developed countries, where only one threshold is to be found which has screenn to have any significance. Thus fit in to the non-linear mechanism that derives , the magnitude of the negative refer that inflation has on the growth falls with an increase in inflation age at lower than moderate level of inflation, the effect is charge positive on the level of investment (Li M. , 2006).Li concludes her research with the findings that consistently support the nonlinearity of relationship between inflation an economic growth or performance. Li, also finds that the policy makers should not keep inflation rate at zero as single digit inflation does not hinder rather as yet stirs up economic growth. Furthermore, a hyperinflation, the one that surpasses beyond the second threshold level, does not have a an even worse negative impact on growth, rather the marginal impact actually falls with increase in inflation level. Thus coverling a moderate level of inflation should be a coun trys primary goal pertaining to inflation (Li M. , 2006).The discussed literary findings proceed with the impact of inflation on the capital accumulation and the economic growth. Winding its path along other literature contents, the muse of inflation effects on the economic growth finds its way into a research conducted by M. Ali Kemal in Is inflation in Pakistan a Monetary Phenomenon? during the course of conducting research, Kemal attempted to analyze and identify the impact that other agents, specifically reposition in coin supply, would have on the rate of inflation. Kemal found that an increase in coin supply over a long period leads to high inflation. The concluded research of Kemal, besides having relevance to our research, provided a decent level of support to the quantity theory of money as well. Thus empirically coming to a conclusion, Kemal claimed that inflation is indeed a pecuniary phenomenon. In order to write up the impact of inflation on economic growth, it i s pertinent that we examine the effect of other factors on inflation as well and employ it in enhancing our understanding of the important of inflation in the growth process.According to Kemal, a change in money supply effects the rate of inflation in the long run. Since the Quantity Theory of Money also holds in the long run, this led him to believe and later on evidently be that inflation is a monetary phenomenon (Kemal, 2006).Kemal argues that money supply does not have an immediate impact on the price levels. on the contrary, a change in money supply would start indicating any affected changes in the price levels with a lag of about 9 months time. The study conducted by Kemal, emphasize the efficiency of the system that the money supply works through, showing that it takes less than a year to convey an induction. However, it also points out that once a stir up takes place, the system takes it time to achieve equilibrium state again under the circumstances that the induced cha nge works it way from a change in one the tercet variables which include GDP, money supply and prices. In the short run, the impact of a change in money supply on inflation in not instant. the effect seeps through the system to actually induce any change with a lag of at least a period of 3 quarters (Kemal, 2006).Having had proven that inflation is a monetary phenomenon through evidence provided by Kemal, we move on towards the research conducted by Abdul Qayyum who, in his study Does Monetary Policy Play Effective Role in controlling Inflation in Pakistan, has conducted a research in the light of the data forthcoming for Pakistan in order to get a clearer understanding of monetary Policy framework and the extent to which and how it controls inflation specifically in Pakistans economy. this includes a number of factors that are a source of rise in price level like wages, exchange rate, external shocks, depletion of natural resources, taxes etc. wheat prices have specifically been allegedly been known as the cause of the increasing inflation in Pakistan (Government of Pakistan, Various Issues).Following what Abdul Qayyums research study , we found through the inflation control in not a recent phenomenon, but a topic of interest and of utmost importance since 1970s. there have been many debates regarding the causes of inflation however, controlling it is an together with agreed topic of prioritized importance among economists and policymakers. which makes it central banks responsibility to control inflation, since central controls monetary policy and inflation is deductively a monetary phenomenon. The thing that most intrigued in Abdul Qayyum in this regard was the effectiveness of monetary policy in controlling inflation. we find out from the data provided for Pakistan that whenever the money supply target was controlled the inflation was controlled successfully (Qayyum, 2008).However, not too many rare occasions like this have occurred and due to the abse nce of coordination between the disposal and the central bank, the implementation of monetary policy has mazed its effectiveness. Other problems have risen as well and the monetary policy has been experiencing inconsistency in reaction time along with ineffectiveness, nevertheless, we have evidence passable from the recent years of the effectiveness of monetary policy in controlling inflation by observing that when SBP failed to control the money supply , it consequently failed to control the rate of inflation within the target levels. If worked out efficiently it produces outcome effectively (Qayyum, 2008).another(prenominal) study Does Volatility in Government Borrowing Leads to Higer iInflation? conducted by Adnan Haider and Safdar Ullah Khan analyzes the impact of volatility in the borrowing of the governance from the central bank on the rate of inflation that persists domestically in Pakistan. The findings of the research study that was conducted for the sake of examining t he sensitivity of inflation rate to volatility in government borrowing, indicate that there exists a relationship between the two especially in the long run. The research was conducted in the light of supporting fiscal dominance hypothesis in the determination of in inflation in Pakistans economy (Haider Khan, 2007).The result enlightens us with very important piece of information pertaining to the relationship, in connection with the fiscal dominance hypothesis, between the two variables volatility in governments borrowing and the inflation rate. Its indicates that a significantly strong relationship exists between the two. even in the long run this relationship holds significantly. According to Haider and Khan, the estimated coefficient implies that one standard deviation change in volatility in borrowing from the central bank leads to a change of 8.5% in domestic inflation. specifically it indicates a relationship but not the direction or the causal dynamis of the relationship. these findings lead us to posession of evidence relationg to the importance of monetary policy in affecting inflation which in turn effects the economic growth (Haider Khan, 2007).Pertaining to the factors that affect the inflation, political stability goes hand in hand in holding equal importance with regards to being a factor determinant of the inflation in an economy. Safdar Ullah Khan, together with Omar Farooq saqib conducted a study Political Instability and Inflation in Pakistan, to investigate the impact of the derangement in government and political situation in the country on inflation rate in Pakistan. The results are implies in terms of monetary model and in terms of non monetary model. In term of monetary model, results conclude that the monetary determinants effect inflation marginally and they are dependent upon the political situation of the country. (Khan Saqib, 2008)In non monetary terms, Adnan and his associate found a positive relationship between the variabl es political instability and inflation. The analysis was done on interactive dummies that represent political instability and induce high inflation. The research may, however, also lead us into believing that inflation is a non monetary phenomenon due to its strong affiliation with changes in government infrastructure and political crisis. It may also lead to an implication that government crisis rather than oil prices are responsible for the high inflationary pressure. Nevertheless, we observe a lack of significant research studies relating these two variables and given the high volume of political unrest in our country in the recent years (Haider Khan, 2007).In his other paper, Qayyum attempted to examine the link between the excess growth in money supply and inflation in Pakistans economy, investigated the soundness of the theroy that inflation is a monetary phenomenon. Qayyum conducted this research to come with an outcome that indicated that there is a positive alliance betwee n inflation and money supply growth. The way the implication of the research went about is that the growth in money supply at first affects the GDP which in turn affects inflation. This further indicates and hence, implies that money supply growth is a factor contributor in rise of price level. Thus money supply affects inflation and we can deduce from this implication that inflation is after all a monetary phenomenon , which is controlled by monetary policy and can be controlled by tight monetary regulations (Qayyum, 2006).The validity of the theory has been confirmed by the study conducted consisting of tests and analysis by Qayyum and therefore its stands safe to assume that money supply is one of the key determining factors of inflation in Pakistan. To find the relationship between money growth and inflation, Qayyum estimated the relationship between the rate of inflation, money growth, growth in real income, and growth in velocity in Pakistan for the data provided cover versio n the 1960-2005 period. An important conclusion that surfaced from this research was that there exists a significant relationship between the variable inflation and money growth proving that the growth in money supply is a vital contributor to the rise in inflation. Furthermore, even the recent act by the State Bank of Pakistan to tighten the monetary policy, supports the theory that inflation in Pakistan is a monetary phenomenon. (Qayyum, 2006).The same argument was made by Wasim Malik in his study Money, Output and Inflation that the effect of changes in money supply seeps into output through inflation, however, with some lags. And through a series of tests Malik found that above hypothesis cannot be rejects owing to its strong and valid stance. Malik claims that the three possible argument can explain the high inflation in history including monetary policy, supply side factors and foreign inflation. tests however show that effect monetary policy transfers into inflation with a l ag of half a year and then takes another year to reach the peak. The reason why this happens can be explained by two possible situations, according to Malik First, central bank focuses on future targets more than on the previous trends while deciding on the money growth and second, th central bank does that out of fear of losing higher growth (Malik, 2006).Having analyzed the research studies, that examine variables affecting inflation and description it a monetary phenomenon and we come back to our literature review in examining the literature contents that would help us find material evidence on the importance of inflation and its relationship to growth. So far conclusive researches conducted by Min Li have been very helpful and have been supporting our anticipate findings smoothly. This brings us to reviewing a research by Vikesh Gokal and Subrina Hanif on Relationship Between Inflation and Economic growth. These authors work their way through research with the initial musing that show the many developed countries have a predetermined goal of achieving high growth and maintaining it side by side with a low inflation rate. This inspired them to carry on with their research given o much importance that it holds in the economy.The nature of relationship that exists between inflation and growth has been a debatable topic for quite some time. The authors have reviewed different theories on the inflation-growth relationship including those that are Classical emphasizes on the need to save and invest for growth purposes, Keynesian emphasizes on the critical role of monetary growth in changing inflation rates and Neoclassical emphasizes on the impact the inflation has on capital accumulation and investment. The paper also reveals the findings of other research studies conducted n this filed and incorporating their results to conclude their own research, testing whether a momentous relationship exist between the two mentioned variables (Gokal Hanif, 2004).Contra ry to what Li found later on, Hanif and Vikesh found there, to be a weak correlation between inflation and growth. Also the causality was found to be running from GDP to inflation. These results were in accordance and derived from the review of other research studies conducted by authors before their own time. According to Michael Sarels inflation impacted a negative growth after 8% (Michael Sarel, 1996). In another research authors found the threshold of inflation in industrial countries to be around 1-3% and in developing countries o be 11-12 % (Khan Senhadji, 2001). These findings led the authors of this paper to conclusions that the two variable inflation and growth has weak negative correlation and the causality ran from growth to inflation rather than what was proposed and found by Li later in time (Gokal Hanif, 2004).Following the course the was led by Gokal and Hanif, Chimobi conducted a study in Nigeria to follow a similar suit of finding any existing relationship between inflation and economic growth, but his study was specific to Nigeria. Chimobi found, as a result of the study he conducted based on the data for Nigeria inflation and growth over the period 1970-2005, that there was no co-integrating relationship between inflation and economic growth for Nigeria. The second attempt the author made in his research as to determine the causality of the relationship between inflation and economic growth. Conclusively a unidirectional causality was found between the variable running from inflation to economic growth that were in orderly support of what Min Li found, however quite the contrary to what Gokal and Hanif proposed (Gokal Hanif, 2004). This was an indication implied by the empirical evidence that a relationship does exist between inflation and economic growth and inflation indeed does have an impact on economic growth (Chimobi, 2010).However it was not concluded whether the relationship that existed between inflation and economic growth was po sitive or negative for Nigeria. We can only deduce from other studies that have been reviewed in literature that inflation has never had a favourable impact on the economic growth outcome (Chimobi, 2010). This shall be covered in the discussion to come. A study estimate of the threshold level of inflation in Pakistan was covered by Yasir Ali Mubarik in his research on Inflation and Growth. According to the research conducted by Yasir, a finding surfaced that showed that threshold level of 9% exists in Pakistan beyond which inflation will be rendered harmful for economic growth (Mubarik, 2005).Having put the home dataset through causality test and then analyzing it for sensitivity for inflation and economic growth the research concluded the some findings that include the existence of a relationship between inflation and economic growth. Since a threshold level was determined , any impact of inflation on economic growth, whether negative or positive, is still considered as a relations hip between the two variables. Another finding that was deduced was that there existed a unidirectional relationship between the variables running from inflation to economic growth. Since inflation was found to have a negative impact beyond a threshold level on the economic growth, therefore, the relationship was taken to be causal running from inflation to economic growth and not vice versa. the research conducted however did not specify a lower level of threshold below which economic growth would not occur. Regardless the research poses as an important conclusion for the policymakers (Mubarik, 2005).A study analysis of Relationship between inflation and growth is performed by Erbaykal Okuyan in their study Inflation in Pakistan in which the relationship between the inflation and the economic growth in Turkey has been examined for the data covering the period of 1987-2006. Through their research they discovered the existence of a long term relationship between the two variables In flation and economic growth in turkey. Using the causality test used by Toda Yamamoto, Erbaykal Okuyan examined the causality relationship between the two (Yamamoto, 1995). However, they found no causal relationship between the two variable from economic growth to inflation but they did found a causal relationship from inflation to economic growth. implying the inflation has an impact on the economic growth (Erbaykal Okuyan, 2008).Khan Schimmelpfennig, in this paper observe the factors that help forecast inflation in Pakistan and explain it. The research conducted by Khan Schimmelpfennig emplys a simple inflation model, which includes standard monetary variables (money supply, credit to the hidden sector), an activity variable, the interest and the exchange rates, as well as the wheat support price as a supply-side factor to estimate the forecast while indicators like private sector credit growth and broad money growth are considered effective for inflation forecast which can b e used for future developments pertaining to inflation. The results found empirically during the course of the research conducted by Khan Schimmelpfennig show that monetary factors are good indicators of inflation, since inflation is a monetary phenomenon (Khan Schimmelpfennig, 2006).Thus, according to Khan Schimmelpfennig, the two key variables that explain inflation developments are Broad money growth and private sector credit growth. In order to control Inflation in Pakistan and thus spur growth ,price stability should be the prime objective of the SBP. With monetary policy in action, the exchange rate shall no longer be able to offset the effect external shocks on the economy which leaves the SBP with nothing but to maintain price stability, which will ultimately prove to be the best policy contribution for sustained growth. The course of the research provided us with results that show that in the short run, there may not be a trade-off between inflation and growth, however, in the medium- and long-run, it blissfully exists. Moreover the authors argue that monetary policy should be more concerned with core inflation because given the volatility in some part of CPI, food prices and energy prices, core inflation is a better measure of underlying trends of inflation than advertise inflation. Furthermore, the authors conclude that even though core inflation is the right tool for monetary policy, nevertheless, the SBP must keep a watch over headline inflation. (Khan Schimmelpfennig, 2006).