Effect of Inflation Growth Rate on GDP Growth Rate - 1981 to 2012

Posted in Finance Articles, Total Reads: 1896 , Published on 30 November 2014
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The Relationship between inflation and grow is very controversial topic. There are three possible results regarding the impact of inflation on output and growth: i) none; ii) positive; and iii) negative.


There are three types of Inflation. When the price level increases because of the increase in demand, it calls Demand Pull Inflation. When the cost price of the production is increases and the selling price is also increase, it calls Cost Push Inflation. Monetarists view of inflation is that as per monetarists (new classical economists) inflation is caused due to the excessive supply of money in the economy. According to monetarists an increase in money supply results in higher aggregate demand. Monetarists assume the economy to operate as full employment level of output, thus, any increase in demand is purely inflationary. The increase in money supply is happen because of the expenditure made by the government for the growth and development of the Country. So this study is working on the concept of the Monetarists.

Image Courtesy: freedigitalphotos.net, cooldesign


Methodology of the Study

2.1 Research Statement:

To study the effect of Inflation Growth rate on the GDP Growth Rate during the period of 1981 to 2012.


2.2 Assumption:

2.2.1) The GDP growth is only depends on the Inflation growth rate. All other factors are constant.

2.2.2) The data from world Bank is accurate and there are not any mistakes.


2.3 Research Questions:

2.3.1) Is there any Relationship between Inflation and GDP in India during the time period of 1981 to 2012?

2.3.2) Is there any difference between the Relationship between Inflation growth rate and GDP growth rate in India before LPG and after LPG?


2.4 Objective:

2.4.1) To understand the relationship between Inflation growth rate and GDP growth rate in India.

2.4.2) To find the difference between the relationship of before LPG and after LPG in India.


2.5 Theoretical Foundation:

2.5.1) GDP Growth Rate-

GDP Growth rate is calculated for the Research as annual percentage growth rate of GDP at market prices based on constant local currency. Aggregates are based on constant 2005 U.S. dollars. GDP is the sum of gross value added by all resident producers in the economy plus any product taxes and minus any subsidies not included in the value of the products. It is calculated without making deductions for depreciation of fabricated assets or for depletion and degradation of natural resources.

2.5.2) Inflation Rate-

In this study, for measuring Inflation, the CPI growth rate has been taken. Inflation as measured by the consumer price index reflects the annual percentage change in the cost to the average consumer of acquiring a basket of goods and services that may be fixed or changed at specified intervals, such as yearly.


2.6 Parameter of Interest:

2.6.1 GDP- Gross domestic product (GDP)

Gross domestic product (GDP) is the market value of all officially recognized final goods and services produced within a country in a year, or other given period of time. GDP per capita is often considered an indicator of a country's standard of living.


2.6.2 How Inflation measured in India-

Inflation is usually measured based on certain indices. Broadly, there are two catagories of indiaces for measuring inflation i.e. Wholesale Price Index and Consumer Price Index.

• India uses the Wholesale Price Index (WPI) to calculate and then decide the inflation rate in the economy.

• Most developed countries use the Consumer Price Index (CPI) to calculate inflation.


2.7 Benefits of the Study:

2.7.1) The study can helpful to the policy maker for taking Decisions.

2.7.2) The study can helpful to understand the situation of Inflation in India and other Countries.

2.7.3) The study can helpful to understand the advantages and disadvantage of Inflation


2.8 Limitation of the Study:

2.8.1) The study has been done for a very long period i.e. 1981 to 2012. So there may some data error.

2.8.2) The researcher has assumed that the GDP is only affected by Inflation and other factors are constant.

2.8.3) The research has been only done for some Countries and the selection of the countries are not done with any criteria.

Ch – 3 Data Analysis


3.1 Data Collection:

All the data have been collected from the World Bank. The data have been collected for the time period of 1981 to 2012


3.2 Techniques:

For finding the relationship between Inflation growth rate and GDP growth rate, Ordinary Least Square Method has been used. To analyze the data, the SPSS software has been used. To fing the Autocorrelation between Inflation growth rate and GDP growth rate, Durbin Watson Test has been used.


Finding & Recommendation

4.1 Output & Findings-

The P Value of Indian data is 0.654. P value is greater than 0.05 (P value>0.05).So the H0 should not be accepted. It means that there is no significant Relationship between Inflation and GDP growth rate in India. The R Square is 0.007. It means that the GDP growth rate can be explained 7 % by the Inflation growth rate. The Sum Square of Residuals is 166.897 and SSR is 1.142. Here, the errors are very high in the regression. So the regression is not appropriate. The Errors should be near to zero.


By studying the result of the analysis of the data, it has been found that there is no significant relationship between GDP growth rate and Inflation Growth rate. The Durbin Watson test indicates that there is a negative co-relationship. We can say that in India, the Growth of the economy is not affected by Inflation growth rate.


There are many reasons for the no relationship between Inflation and GDP growth rate. India is developing country. It suffers high inflation rate in last few years from 2008. As the country is developing, the economy of the country is also not stable to digest the bed effect of inflation. On the other side, there are many other factors which are affected to the growth rate. Because of high inflation rate, the country may also faces the problem of interest rate, Foreign exchange rate depreciation, balance of payment and less foreign Reserves etc. so this factors also highly affect to the growth rate of the country. The different policies of government also very important for the growth rate of the India.


• Before 1991:

The P Value of data before 1991 is 0.656. P value is greater than 0.05 (P value>0.05). It means that there is no significant Relationship between Inflation and GDP growth rate in India. The R Square is 0.023. It means that the GDP growth rate can be explained 2.3 % by the Inflation growth rate. The Sum Square of Residuals is 47.886 and SSR is 1.132. Here, the errors are very high in the regression. So the regression is not appropriate. The Errors should be near to zero.


In short, there is no relationship between Inflation and GDP growth rate before 1991 in India. Durbin Watson test indicates that there is a positive co-relationship between Inflation growth rate and GDP growth rate.


Before 1991, the Indian economy was closed economy. The country is very less developed at this time. The inflation was very high before 1991. The inflation was 8 to 11 percentage at that time. In 1991, the inflation was 13.87 %, which is very high. Before 1991, there is no significant effect of inflation on growth rate which may be because of the threshold effect. The threshold level may be different from country to country. Pakistan is also developing country like India. One research on Pakistan done by Moihhamad ayyub and Faruq (2011) find the threshold level is 7 %. So above the 7 % inflation, it could not give positive effect on the inflation.


• After 1991

The P Value is 0.839, P value is greater than 0.05 (P value>0.05). It means that there is no significant Relationship between Inflation and GDP growth rate in India. The R Square is 0.003. In ideal situation, the R square should be more than 60 %. Here it is 3 %. It means that the GDP growth rate can be explained 3 % by the Inflation growth rate. The Sum Square of Residuals is 64.294 and SSR is 0.198. Here, the errors are very high in the regression. So the regression is not appropriate. The Errors should be near to zero.


Here also the P value is less than 0.05. So the H0 will not be accepted and there is no significant relationship between Inflation growth rate and GDP growth rate.


After the LPG has launched, the Indian economy has been totally changed. After the immediate of LPG, there was a high inflation which becomes stable in the period of 2000 to 2005. Then again because of the opened economy, the financial crisis of foreign country has badly affects to the economy and again the inflation level goes up high. So that the economy is not properly stable to capture the positive benefits of the rising inflation rate.


This article has been authored by Roshni Patel from IIFL


Bibliography:

• http://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG

• http://data.worldbank.org/indicator/FP.CPI.TOTL.ZG



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