The Determinants of Inflation in Sri Lanka

Abstract

A high and sustained economic growth in conjunction with low inflation is the central objective of macroeconomic policy formulation in both developed and developing countries. Further, studying inflationary processes is an important issue in the current scenario as it allows policy-makers to achieve monetary and economic targets. However, it is not an easy task, especially in developing coun-tries, where economic processes are highly unstable and volatile. The situation in Sri Lanka is not exceptional. Therefore, understanding the behaviour of inflation is vital for the policy-makers in macroeconomic management as Sri Lanka is currently moving into new era of economic development. This article investigates the determinants of inflation in Sri Lanka during 1993–2008, a period which was characterized by upward and downward trends in the economy. Vector auto-regressive (VAR) models were used to find out appropriate explanations for inflation with accompanied application of Granger Causality Tests. The overall findings of estimated VAR models imply that the money supply, exchange rate and the GDP have information which helps in exploring the behaviour of the inflation in Sri Lanka.