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Growth-inflation nexus: threshold model of inflation in India

Author: 
Dr. Debesh Bhowmik
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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