Growth-inflation nexus: threshold model of inflation in India
Subject Area:
Social Sciences and Humanities
Abstract:
In this paper,
author tries to relate inflation rate (measured both by CPI and WPI)
with growth rate in India during 1960-2015 and calculated target rate of
WPI and CPI. Author used Bai-Perron test (2003) for structural breaks
and also used Granger Causality test (1969), Johansen cointegration and
vector error correction models (1991,1996) for relationship and used
residual test for autocorrelation and found impulse response functions
for convergence and stability for both CPI and WPI with growth. By
taking Khan and Senhadi model (2001), author found out the target rate
of CPI and WPI for India. Author observed that one per cent increase in
whole sale price index per year leads to 0.59 per cent increase in GDP
growth rate per year in India during 1960-2015. The WPI granger cause
growth rate but not vice versa i.e. causality is uni-directional. Growth
and WPI is cointegrated in the order of one. VEC Model is stable but
change in WPI has slow error correction whereas change in growth rate is
not a good fit but its error correction process is faster than change
in WPI. Its residuals are not normal having autocorrelation problem and
impulse response functions are diverging. During 1960-2015, WPI has four
structural breaks at 1974, 1988, 1995 and 2008 respectively. Above the
threshold level of WPI=4.12 with 2010=100, the inflation-growth nexus
tends to negative. The paper also found that one per cent increase in
consumer price index per year leads to 0.55 per cent increase in GDP
growth rate per year in India during 1960-2015. The CPI granger cause
growth rate but not vice versa i.e. causality is uni-directional. Growth
and CPI is cointegrated in the order of one. VEC Model is stable and is
highly good fit but only error correction process of change in growth
rate is significant for speedy correction. Its residuals are not normal
having autocorrelation problem and impulse response functions are
diverging. During 1960-2015, CPI has four structural breaks at 1974,
1987, 1996, and 2008 respectively. Above the threshold level of
CPI=3.258 with 2010=100, the inflation-growth nexus tends to negative.
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