Professional Documents
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79
Thoughts on Economics
Vol. 22, No. 04
1. INTRODUCTION
80
Thoughts on Economics
81
82
This study has made use of secondary data analysis, and data on the CPI,
broad money supply and the nominal exchange rate are collected from
Bangladesh Bank, Monthly Economic Trend, and on real GDP are collected
from various issues of Statistical Yearbook of Bangladesh, Bangladesh
Bureau of Statistics, and Bangladesh Economic Review. To estimate the
autoregressive parameters of the models, annual data from 1981 to 2011 are
used. Here, real GDP is calculated at 1995-96 constant market prices, while
the base year for CPI is 1995-96, i.e., 1995-96 = 100. All the variables are in
logarithm form. Definitions of the variables are, LCPI = Log of Consumer
Price Index, LM2 = Log of Broad money supply, LRGDP= Log of Real
GDP, LNER = Log of nominal exchange rate
4.2 RESEARCH METHODS
In this paper a series of tests such as unit root, cointegration, diagnostics test,
vector error correction models (VECM) have been carried out. Granger
causality test was also conducted to test the causality. These tests examine
both long-run and short-run relationships between consumer price index and
the economic variables. The VECM analyses provide some support for the
argument that the lagged values of macroeconomic variables have a
significant influence on the inflation. They also provide important
information to forecast future values of the inflation. Econometric Software
Programming R is used for finding the estimates.
4.3 LAG LENGTH SELECTION
Thoughts on Economics
83
AIC
-7.090
-7.238
-7.167
-7.151
-7.073
BIC
-7.050
-7.184
-7.099
-7.069
-6.978
HQ
-6.944
-7.043
-6.923
-6.858
-6.7318
LRGDP
Lag
AIC
-9.845
-9.767
-9.698
-9.619
-9.689
BIC
-9.804
-9.713
-9.630
-9.538
-9.594
HQ
-9.698
-9.572
-9.454
-9.3267
-9.3478
LNER
Lag
AIC
-6.8877
-7.359
-7.3014
-7.2376
-7.327
BIC
-6.847
-7.3053
-7.2338
-7.156
-7.232
HQ
-6.741
-7.164
-7.0576
-6.9451
-6.9859
LCPI
Lag
4.4
AIC
-7.539
-7.838
-7.7616
-7.8135
-7.7548
BIC
-7.49849
-7.784
-7.694
-7.7323
-7.660
HQ
-7.3927
-7.6436
-7.5178
-7.5209
-7.4135
ORDER
STATIONARITY
OF
DIFFERENCING
AND
TESTING
FOR
84
In Table 4.2, results of the unit root tests on concerned variables have been
reported. The tests for non-stationarity show that LCPI is non-stationary
based on ADF, PP, and KPSS tests. The first difference of LCPI is stationary
based on PP, and KPSS tests although the ADF test fails. Since the PP and
KPSS tests are preferable to ADF it can be concluded that LCPI is also
stationary, I (1). The results also shows that at 5% significance level all the
other variables are non stationary at levels since the calculated tau values are
less in absolute terms than their critical values and the variables are found to
be stationary only when tested at first difference. Thus, they are integrated of
order one -I (1). Each of these variables becomes stationary if it is
differenced once.
Table 4.2 Unit Root Test Statistics
Variab
les
LCPI
LRGD
P
LM2
LNER
Level/di
fference
L
a
g
s
ADF
PP
KPSS
Intercep
t
Intercept
& Trend
Interce
pt
Intercep
t
&
Trend
Intercept
Intercept
& Trend
DECISIO
N
Level
-1.22
-3.2118
-2.90
-3.2911
1.0802
0.2282
Non
stationary
First
Differen
ce
-2.13
-1.5514
-3.65*
-3.5418*
0.5205***
0.1938***
Stationary
Level
2.177
2.3703
0.4841
-3.15
1.0834
0.242
Non
stationary
First
Differen
ce
1.37
-0.5595
-8.69*
-11.75*
0.1375
0.06*
Stationary
Level
0.0344
-2.2516
-0.984
-2.3617
1.0907
0.1442***
Non
stationary
First
Differen
ce
-4.032*
3.2358**
-3.08*
-3.23**
0.2172*
0.1745***
Stationary
Level
-2.0322
-3.5534
1.874
-2.4843
0.4317*
0.0715***
Non
stationary
First
Differen
ce
-3.4622*
-3.3897**
3.00*
-2.9827
0.1375**
0.0569***
Stationary
Notes:
1. L means the series in log level, * and ** means significant at 5-percent and
10- percent levels, respectively.
Thoughts on Economics
85
2. Lag length for ADF tests have been decided on the basis of AIC.
3. Maximum Bandwidth for PP and KPSS tests have been decided on the basis
of Newey-West (1994).
4. All tests have been performed on the basis of 5-percent significance level
using R version 2.12.2
5. The ADF and PP tests are based on the null hypothesis of unit roots while
the KPSS test assumes the null hypothesis of stationarity.
6. For KPSS test, *, ** & ***means the null hypothesis accepted at 1percent,
-percent and 10- percent levels, respectively.
4.5 GRANGER CAUSALITY TESTS
Table 4.3 shows the results of the Granger causality test conducted for the
respective variables of the model. The null hypothesis in each case is that the
variable under consideration does not Granger cause the other variable.
Table 4.3 is analyzed at 5% significance level. The tests found that money
supply does Granger cause consumer price index (inflation rate). It is
evident, therefore, that the direction of causality runs from money supply to
consumer price index. Hence the causality here is unidirectional.
Bidirectional causality was found between LGDP and LCPI (inflation rate).
Unidirectional causality was found between LNER and LCPI (inflation rate).
It is evident, therefore, that the direction of causality runs from nominal
exchange rate to money supply. Hence, causality is unidirectional. The test
also found that nominal exchange rate does Granger cause real GDP. Hence,
causality is unidirectional.
Table 4.3 Results of Pair wise Granger causality Tests
86
Null Hypothesis:
F-Statistic
p-value
2.0461
0.0314*
0.2084
0.0427*
0.8233
0.4456
3.2118
0.0498*
0.8806
0.4217
5.018
0.0108*
0.2473
0.7820
LNER does
LRGDP
5.5143
0.0073*
7.5977
0.0014*
0.2377
0.7894
1.2925
0.2848
1.7277
0.1895
not
Granger
cause
LRGDPt
e1t
+
e2t
Thoughts on Economics
87
Variable
lag
Model
LCPI,
-1
LM2
LCPI,
Model
-2
-3
Test
p~value
MARC
H
p~value
Portmant
eau Test
p~value
p=3
3.3182
0.5061
52.2033
0.2143
42.8488
0.8132
p=2
3.6733
0.452
47.944
0.3543
46.2872
0.8194
p=1
15.879
0.003186
39.9147
0.6867
61.8743
0.409
p =4
0.1081
0.9908
126
0.9992
106.1218
0.5331
p=3
6.1175
0.1060
132
0.9971
114.8545
0.5388
p=2
23.534
3.125e-05
138
0.9913
105.3269
0.9096
p=1
18.874
0.0002903
144
0.9775
124.7901
0.7247
p =4
10.810
0.2127
210
232.3488
0.02478
p=3
6.7492
0.5639
220
201.4034
0.6157
LM2,
LRGDP
Model
JB-
LCPI,
LM2,
LRGDP,
88
LNER
p=2
21.627
0.1356
230
179.3016
0.9874
p=1
53.567
8.377e-09
240
222.0211
0.7914
Table 4.5 Johansen Test for Co-integration (Maximum eigen value Test)
Test
Variable
H0
H1
Statistics
Critical Values
Conclusion
Thoughts on Economics
89
r<=1
r=2
23.16
28.76
23.11
25.54
30.34
r<=2
r=3
11.98
14.98
16.85
18.96
23.65
r<=3
r=4
10.22
12.01
10.49
12.25
16.26
LCPIt=11+11
LCPIt-1+
1a
12
LM2t=12+21
LCPIt-1+
..1b
2t
12
LM2t-1+
LM2
Dt
+
t-1
+1t
Dt+
The estimated coefficients of the error correction term (long-run effects) and
the lagged values of the two series (short-run effects) are presented in Table
4.6.
Table 4.6.The Error Correction Model-1
Variables equations
LM2t-1
LM2t
LCPIt
-0.3039
0.02501
(0.0590)
(0.03733)
{-5.151*}
{-0.670}
[2.83e-05]
[0.50918]
2.6801
-0.2063633
(0.5103)
(0.3228424)
{5.252 *}
{-0.639}
[2.20e-05]
[0.52874]
0.1794739
0.2075785
(0.1297705)
(0.0821030)
90
{1.383}
{2.528*}
[0.179]
[0.01845]
0.2840767
0.4338898
(0.2080724)
(0.1316429)
{1.365}
{3.296*}
[0.185]
[0.00304]
Multiple R-squared:
0.9677
0.9323
Adjusted R-squared:
0.9623
0.921
179.8
82.59
p-value: 1.135e-13
0.0321
0.02031
LCPIt-1
F-statistic:
Residual standard error:
Chi-squared value
df
p-value
Thoughts on Economics
1. Normality test(JBTest)
2.
serial
correlation
test(Portmanteau Test)
3.ARCH (multivariate)
91
VEC (2)
VEC (3)
VEC (2)
VEC (3)
VEC (2)
VEV (3)
with r=1
with r=1
with r=1
with r=1
with r=1
with r=1
0.338
0.5926
6.8183
4.626
93.9629
106.36
129
120
0.9912
0.8085
138
132
180
180
0.9913
0.9971
The diagnostic tests for the VECM equation confirmed its coefficient
stability. The Jarque-Bera test did not reject the null hypothesis of a normal
distribution of the residuals (at 5 percent significance level) and the
Portmanteau test as well as the correlogram of squared residuals did not
show any autocorrelation or ARCH in the residuals. The short-run Dynamic
Adjustment using VEC for model-1 and model-3 has been also done,but it is
not shown in this paper.
92
about 6.94 percent, 6.43 percent, 5.81 percent, 5.55 percent and 5.50
percent, respectively, in fiscal year 2011-12, 2012-13, 2013-14, 2014-15,
2015-16 as against 6.7 percent in fiscal year 2010-11. And the forecasted
Period Average Exchange rate will be about 77.78 Taka/USD, 80.42
Taka/USD, 83.46 Taka/USD, 86.89 Taka/USD and 90.3 Taka/USD,
respectively, in fiscal year 2011-12, 2012-13, 2013-14, 2014-15, 2015-16 as
against 74.15 Taka/USD in fiscal year 2010-11. A gradual depreciation of
Taka-USD will occur in the medium term in line with current policy
intervention (Table 5.1).The findings of model-1 and model-2 shown in
Table 5.1
Forecast
value for
model-2
on
15.
9
408995
.7
6.2
2
16.
78
432959
.7
5.8
6
Infl
atio
n
Rat
e
Broad
Money
(M2)(Taka
in crore)
M2
Gro
wth
20112012
261.4
4
8.4
7
523996.
35
18.
95
20122013
282.6
8
8.1
3
611573.
24
16.
71
20132014
304.3
2
7.6
5
703139.
09
14.
97
20142015
326.0
8
7.1
5
801187.
27
13.
94
20152016
348.0
1
6.7
2
909872.
72
13.
57
20112012
260.7
5
8.1
8
510542.
93
20122013
279
596234.
9
Year
Forecast
value for
model-1
on
VEC(2)
Real GDP
(Taka in
crore)
Rea
l
GD
P
Gro
wth
CPI
(Base:
19951996)
NER
NE
R
Gro
wth
Thoughts on Economics
VEC(2)
Forecast
value for
model-2
on
VEC(3)
Forecast
value for
model-3
on
VEC(2)
93
201
3201
4
297.6
1
6.6
7
705674.
95
18.
36
456968
.6
5.5
5
20142015
318.0
8
6.8
8
838340.
82
18.
8
481128
.7
5.2
9
201
5201
6
340.7
5
7.1
3
991803.
22
18.
31
505816
.9
5.1
3
20112012
250.4
3.8
9
498380.
94
13.
13
412800
.6
7.2
1
20122013
259.7
5
3.7
3
577746.
23
15.
92
439340
.5
6.4
3
20132014
277.5
6
6.8
6
689119.
52
19.
28
464046
.5
5.6
2
20142015
298.9
4
7.7
809352.
64
17.
45
489544
.2
5.4
9
20152016
319.4
2
6.8
5
937423.
09
15.
82
516303
.5
5.4
7
20112012
257.5
6
6.8
6
491796.
36
11.
64
411790
.5
6.9
4
77.
78
4.9
20122013
271.1
5
5.2
8
564254.
12
14.
73
438283
6.4
3
80.
42
3.4
20132014
286.6
4
5.7
2
660650.
34
17.
08
463749
.6
5.8
1
83.
46
3.7
8
20142015
304.5
7
6.2
5
766814.
35
16.
07
489505
5.5
5
86.
89
4.1
1
20152016
323.5
5
6.2
3
883070.
22
15.
16
516442
.9
5.5
90.
3
3.9
3
94
explain 84.94% and real GDP explain 0.6%, period exchange rate explains
9.90%.Therefore, The shock in LM2 has a positive impact on LCPI for all
time periods. The shock in Real GDP has a negative impact on LCPI for
medium term periods.
Table-5.2. Variance Decomposition for VEC model of LM2, LRGDP,
LNER and LCPI.
Variance Decomposition of LM2
Forecast
LM2
LRGDP
LNER
LCPI
1.0000000
0.00000000
0.00000000
0.000000000
0.9281112
0.04691942
0.02190837
0.003060972
0.8730181
0.11087654
0.01199048
0.004114879
0.8243135
0.14594943
0.01454673
0.015190304
0.7932603
0.16294092
0.01909392
0.024704818
0.7711308
0.17530461
0.02219857
0.031366073
0.7518035
0.18553372
0.02552378
0.037139008
0.7351727
0.19332417
0.02914722
0.042355903
0.7215745
0.19918010
0.03247602
0.046769331
10
0.7104130
0.20382182
0.03534363
0.050421531
Horizon
LM2
LRGDP
LNER
LCPI
0.6306442
0.3693558
0.000000000
0.000000000
0.6179559
0.3686398
0.005048734
0.008355577
0.6392246
0.3419106
0.004911274
0.013953483
0.6640160
0.3182072
0.003460403
0.014316414
0.6803065
0.3017387
0.004649569
0.013305183
0.6908565
0.2895759
0.007287709
0.012279853
0.6986915
0.2793220
0.010689863
0.011296607
0.7046832
0.2703145
0.014670275
0.010332046
0.7091762
0.2624614
0.018922521
0.009439930
10
0.7125851
0.2556078
0.023155961
0.008651171
Horizon
LM2
LRGDP
LNER
LCPI
Thoughts on Economics
95
Horizon
1
0.02073619
0.04086744
0.9383964
0.000000000
0.04963582
0.04745808
0.8989852
0.003920943
0.06558947
0.06173850
0.8652608
0.007411260
0.07131477
0.07378131
0.8474333
0.007470586
0.07439737
0.08127628
0.8378113
0.006515078
0.07734745
0.08639471
0.8306029
0.005654945
0.07997100
0.09052459
0.8245386
0.004965796
0.08205271
0.09394412
0.8196184
0.004384773
0.08372893
0.09672721
0.8156489
0.003894935
10
0.08514613
0.09901781
0.8123473
0.003488789
LM2
LRGDP
LNER
LCPI
0.001113351
0.009082615
0.02367268
0.9661314
0.009912304
0.013689889
0.08065954
0.8957383
0.020136422
0.009216613
0.12917521
0.8414718
0.025051094
0.005884118
0.14077007
0.8282947
0.028676439
0.004392340
0.13514071
0.8317905
0.032599881
0.003880304
0.12682869
0.8366911
0.036470520
0.003996506
0.11905307
0.8404799
0.039907461
0.004515394
0.11176028
0.8438169
0.042920881
0.005230819
0.10501476
0.8468335
10
0.045602550
0.006018612
0.09900500
0.8493738
Horizon
Figure5.1 shows the impulse response functions (IRF) for four variable VEC
model. The IRF results show that, the shock in LM2 has a positive impact on
LCPI for all time periods. Therefore, a positive shock to money supply
persistently raises the CPI in the long run. The shock in LRGDP and LNER
has no significant impact on LCPI. This suggests that nominal exchange
rate has no forecasting power of inflation in Bangladesh. The response of
prices to their own shocks is again positive and significant at all time periods
and persistent indicating the inflation inertia. The same finding is also done
for model-1 and model-2, which is not reported in this paper.
96
Figure 5.1 Impulse Responses for VEC (2) models of LM2, LRGDP,
LNER and LCPI
6. CONCLUSIONS AND POLICY IMPLICATIONS
The main objective of the study is to find out the significant factors behind
inflation in the context of Bangladesh during the period FY 1981- FY 2011
and forecasting the data to Medium-Term Outlook (FY 2012- FY 2016). In
this regard, the paper studies the historical trends of inflation and other
macroeconomic variables such as money supply growth, exchange rate
depreciation, real GDP and their relationship. It is observed that Bangladesh
experienced a moderate level of inflation during FY 1992 to 2006. On the
other hand, Bangladesh faced two digit inflation rate most of the time during
FY 1982 to 1991. In regard to cause and sources of inflation, the data reveal
that money supply growth, real GDP growth and exchange rate depreciation
appear significant. The empirical findings strongly support the historical
data that inflation in Bangladesh during FY 1981 FY 2009 was a monetary
phenomenon. The outlook of the model-1 is that the annual average inflation
Thoughts on Economics
97
will cruise within 8.47 percent in FY2011-12 and is forecast to fall gradually
to 6.72 percent by FY 2015-16 which is higher than our expectation, but
forecast values of inflation for model-2 and model-3 are stable. In particular,
VDCs support the view that money supply has an explanatory power of
forecasting the movements in consumer price index (CPI). Also, IRFs show
a positive influence of money supply on inflation rate, which is very much in
line with the outcome of VDCs. So authorities should be cautious while
increasing money supply in the market if they want order to control the
inflation any pressure in the country. From the analysis, we found that if the
government wants to control the inflation rate below 6% in the next five
year, supply of money should not exceed 13% each year. The results from
IRFs and VDCs suggest that the real GDP has a moderate short run negative
impact on inflation rate. So care should be taken so that real GDP does not
fall to keep the inflation as it is. It has also been found that exchange rate
depreciation has a small positive impact on inflation; monetary policy
authority should therefore remain vigilant to prevent erosion of the
exchange rate. In the absence of any direct controlling instrument,
Bangladesh Bank can initiate some case specific counter-action. For
example, it can undertake some responsibilities such as monitoring
modalities of Letter of Credit (L/C) operation so that market forces
determine the exchange rate in a process that remains free from much
speculative transactions.
Empirical results of this study suggest that direct linkages between monetary
policy instrument and inflation appear strong, stable and predictable in
Bangladesh. This study presents clear evidence that the contribution of
money supply is more significant than other variables such as real GDP and
nominal exchange rate.
REFERENCES
Akhtaruzzaman, Md. Inflation in the Open Economy: An Application of the Error
Correction Approach to the Recent Experience in Bangladesh, Working Paper
Series, WP 0602 (2005), Policy Analysis Unit (PAU), Research Department,
Bangladesh Bank.
Bangladesh Bank, Economic Trends Monthly Bulletine, Various Issues 1981-2011
98
Thoughts on Economics
99