Testing the Link between Inflation and Economic Growth: Evidence from Asia
The existence and nature of a link between inflation and economic growth has been the In this thesis, we estimate the relationship between inflation and. 1School of Management, Wuhan University of Technology, Wuhan, China. 2 School The relationship between inflation and economic growth is one of the most. The FT's one-stop overview of key economic data, including GDP, inflation, unemployment, the major business surveys, the public finances and house prices .
Indicators Despite the respectable headline growth figure, pain is deepening in the sectors that have traditionally driven Chinese growth and global commodity demand. Business activity The official PMI is signalling mild contraction in the crucial manufacturing sphere. Other unofficial PMIs suggest the slowdown is more pronounced.
A PMI value of more than 50 indicates expansion. However, Chinese corporates still rely on bank loans for the majority of financing. The inter-bank market accounts for more than 95 per cent of bond trading by volume. It is now phasing out the use of this benchmark rate, and a proliferation of other rates has come into use. The availability of money is also influenced by the mandatory reserves-to-deposit ratio, which the central bank has also been lowering.
Despite this, bank lending trended downwards throughout At the same time as loosening its monetary policy, the government has been selling off its dollar reserves and buying up renminbi, thus shrinking the domestic money supply. Average loan rate A series of benchmark interest-rate cuts and liquidity injections since late have lowered financing costs for companies with access to bank credit, especially large state-owned companies and home mortgage borrowers.
Inflation A collapse in inflation has meant nominal GDP growth has slowed even more sharply than real GDP growth Labour market While economic growth is slowing overall and manufacturing companies are cutting jobs, demand for labour has been propped up by the growing services sector.
Although wages are increasing, discontent lurks below the surface. Vector error correction and Granger Causality test were further performed to discover the short run dynamics of the relationship between the variables and identify the direction of causality. The results reveal that there is a long run negative and significant relationship between the economic growth and inflation in Sri Lanka.
Whereas no statistically significant relationships were found between the variables in China and in India, a negative and significant short run relationship was found for China. The causality results reveal that there is a unidirectional causality that runs from the economic growth to the inflation in China.
The paper discusses the important policy implications of the results. Introduction The relationship between inflation and economic growth is one of the most important economic controversies among the economists, policymakers and monetary authorities in the last few decades. In particular, the core of argument is that whether inflation is necessarily for economic growth or it is harmful to economic growth.
Although the relationship between inflation and economic growth has been widely examined and investigated over the years the relationship is being debated in economic literature.
The empirical and theoretical evidences provide basically three types of relationship between the inflation and the economic growth, positive, negative and none. Early of the twentieth century, where the Keynesian policies predominated, inflation was not regarded as a problem and considered it has a positive effect on the economic growth.
Phillips Curve has taken more attention in the same period and hypothesizes that high inflation positively affects the economic growth by creating of a low unemployment rate. Subsequently, a series of studies found no conclusive empirical evidence for either a positive or a negative association between inflation and economic growth [1,2].
The studies which based arguments on the real business cycle theories and based on cross countries have later demonstrated that there is a negative correlation between inflation and growth in the long run due to the influence of the former on reducing investment and productivity growth.
China inflation slows in sign of ebbing economic growth | South China Morning Post
Nevertheless, a recent study of Reference  analyzes the inflation-growth dynamics in four South Asian countries finds a significant positive relation between two variables in the long run. These divergent results confirm that there is a debate yet on the relationship between inflation and economic growth in the literature. This controversial condition encourages for further studies in examining the dynamics of the relationship between inflation and economic growth.
On the other hand, it is the general consensus that the developing countries are more susceptible to supply shocks causing high variability in inflation and disturb the consumption, investment and production behavior.
Moreover, more government interventions in financial and goods markets and macro economics behavior cause economic instability and market failure.
Therefore, prices do not give correct signals about the policies and the course of actions of the economy agents in the most of developing countries. In this context, the examination of inflation-growth relationship with respect to developing countries is imperative. Thus, this paper seeks to examine the relationship between the inflation and the economic growth in three developing countries in Asia; China, India and Sri Lanka. The rest of this paper is organized as follows.Chinese GDP growth slows again
The next section reviews the literature with relevant empirical studies. Section three describes the methodology used in the study. Next two sections are devoted to present and discuss the results of the present study in order to conclude the paper.
Literature Review The existence and nature of the link between inflation and economic growth have extensively been investigated in the economic literature. Some economic theories explain that inflation is conducive to economic growth and there is a positive relationship between inflation and economic growth . Keynesian Model explains that there is a short run tradeoff between output and the change of inflation, but no permanent trade-off between output and inflation.
The concept of Phillips Curve also hypotheses that high inflation is positively affected economic growth by contributing creation of a low unemployment rate. The Tobin Effect suggests the inflation causes individuals to substitute out of money into interest earning assets, which leads to greater capital increasing and promotes economic growth. In effect, inflation exhibits a positive relationship to economic growth . However, the validity of the positive relationship was questioned in the s.
During the period, numerous studies have been devoted to finding of effect of inflation on economic growth since the economies around the world have experienced hyper-inflation and massive unemployment.
- Overall economic growth
- Sources of growth
Those studies showed that sustained high rates of the inflation can have an adverse consequence on real economic growth even in the long run and repeatedly confirm that inflation has a considerable negative effect on economic growth, at least at sufficiently high level of inflation . Reference , among others, helped to shift the conventional empirical wisdom about the effects of inflation on economic growth from a positive one to a negative one. Relationship between Inflation and Economic Growth: Empirical Studies Examination of the inflation-growth relationship has been a major issue in economic research.
Earlier works on that fail to establish any meaningful relationship between inflation and economic growth [9,10]. Later on, a number of studies have attempted to identify the dynamic of relationship between inflation and economic growth. Similarly, Reference  found no evidence to establish any meaningful relationship between inflation and economic growth by studying 70 countries for a period of However, some studies found that inflation has a negative and significant impact on real economic growth [5,6,9].
The studies based on cross country data show the evidence that long term growth is adversely affected by inflation [6,11,12]. Reference  reports that countries which experienced high inflation rates have also witnessed lower long term growth. The studies based on multi country panel data show that the rate of inflation has an adverse impact on investment that creates macroeconomics stability and growth . Reference  examines the role of macroeconomics factors in growth and finds that growth is negatively associated with inflation and positively associated with good fiscal performance and undistorted foreign exchange markets.
China inflation slows in sign of ebbing economic growth
Fischer further suggests that, since there are no good arguments for very high rate of inflation, a government that is producing high inflation is a government that has lost control. The inflation rate thus serves as an indicator of macroeconomics stability and the overall ability of the government to manage the economy. Reference  validates the positive relationship between inflation and economic growth using a large sample in relation to more than countries for His finding shows that even though for adverse influence of inflation on growth appeared small, the long term effects on standard of living are really sizeable.
Reference  finds a significant negative relationship between inflation and growth by studying 12 Latin American countries. He shows that both inflation and its variance have negative effects on growth, since they are highly correlated in cross country evidence.
The Effects of Chinese Interest Rates and Inflation: A Decomposition of The Fisher Effect
Reference  shows the evidence that the cross sectional correlation between inflation and growth depends on severe inflation observations with high frequency data. Reference [9,16] found support for the view that the negative relationship emerge only when rates of inflation exceed some threshold. Reference [15,17] also questioned whether a uniformly negative relationship exists between inflation and real activities independently of the previous rate of inflation.
They conclude that the relationship between inflation and growth is non-uniform across countries and a vast majority of countries show either uniform or bilateral causality over the selected period.
A series of recent studies provide the evidences to support the argument that inflation has a negative effect on inflation. In fact, Reference  studied inflation and growth relationship in Turkey over 20 years and found a negative short term relationship between the variables.
Reference 20 found a long term negative relationship between inflation and economic growth in Bangladesh. Conversely, Reference  established divergent results, a long term positive relationship between inflation and economic growth, by studying the long term and short term dynamics of the relationship for four south Asian countries; Bangladesh, India, Pakistan and Sri Lanka.
On the other hand, cross country evidences show that countries which experienced higher growth are those with lower inflation rates and higher inflation has an adverse impact on long run economic growth. A study carried out by World Bank states that the high performing East Asian countries had a sustainable high economic growth in the last three decades since a stable macroeconomics environment that fostered high rates of investment and economic growth .
Some of studies argue that negative relationship between inflation and economic growth may be varied between opened and closed economies whereas the relationship is expected to be stronger in opened economies which rely on foreign direct and domestic investment. Methodology The study uses the annual time series data of real GDP growth rate and inflation rate of the three countries from to Since the study focuses the Asian region, three developing countries namely China, India and Sri Lanka were selected.