RELATION BETWEEN GROWTH, INFLATION

AND MONEY SUPPLY

A Report submitted
In Class
Quantitative Techniques in Analysis
Session (Sat 6:30)

To.
SYED ALI RAZA NAQVI

From
SAFDAR BIN ZAFAR (2822)
 Content

ABSTRACT

1 Introduction

Literature Review
2.1 Theoretical Background
2 2.2Empirical Background

3 Model Frame Work

4 Estimation and Result

5 Conclusions

6 References
 ABSTRACT

This paper attempts to investigate the impact of Inflation and Money supply on
GDP in Pakistan, we use the GDP as a (depended) variable and (in depended)
variable selected Inflation-CPI and money supply-M2 as collected the annual
data from The Economic Survey 2009-10.The result was generated on set base
year 2000-01.we use the technique multi regression and data transform in Log
and find significant impact inflation and money supply on GDP.

Keywords: Inflation, Monetary Policy of Money Supply, GDP of Pakistan

1:Introduction

Monetary Policy is one of the most researched topics in economics, because it

has serious implications on growth and inflation within Economy of a country.
This report will help us to determine the facts and factors of inflation and GDP
Growth Rate, which has also been widely debated all over the world. When
inflation crosses reasonable limits, it has negative effects on economy. It reduces
the value of money, resulting in uncertainty of the value of gains and losses of
borrowers, lenders, buyers and sellers. The increasing uncertainty discourages
saving and investment. All this causes result in bad impact on GDP or National
Income.

For Pakistan’s economy, inflation can be bad if it crosses the limit of six per
cent, and can be extremely harmful if it crosses the double digit level. Therefore,
in view of Pakistan economy the choices of appropriate policy become more so
important in order to achieve some important targets i.e. GDP growth Rate along
with reduction of Inflation which is very harmful for any economy. If we can go
through the history of Pakistan economy, Inflation is always left a bad impact on
all sectors of the economy, but amazingly inflation was reduced to below 5
percent in 2000 and remained stable through 2003. Controlling inflation is a
high priority for policy-makers.

In the view of past Inflations result recently policy maker decided to switch an
inflation target regime. The successful Experience may help to draw a very good
lesson for Pakistan Policy Makers. Any economic activity which is shifting
towards inflation and other economic variables need a specific identification. The
introduction will followed by the inflation impact on Pakistan GDP and the role
of monitoring policy.
2: Literature Review

2.1 Theoretical Background:

Literature Review investigates that many economists fall out that one of the
main causes of inflation is excessive money supply growth. Many great
economists always criticize Inflation. “The Irving fisher” he found the quantity
theory of money that shows the positive relationship between quantity of money
and price level (inflation).Inflation Targeting (TI) defines as strategy of Monetary
Policy. Higher Inflation represents low real Cost of Borrowing and its leads to
increase the demand of credit. More ever higher inflation always puts higher
pressure to higher domestic Interest rate.

Money demand stability can be formulated by economic Policies. In Pakistan

continuous changes in Monetary Policies it’s disturb or damage a stable
relationship between stability in Money Demand and reducing inflation. As we go
through the history of Pakistan Economy, its represents that Pakistan always
experienced of inflation and its impact on GDP. In Pakistan its very difficult to
control money demand due to enhancing of Financial technologies innovations.
But from last passing years Monetary Policy are very supportive to promoting
economic growth and price stability by which Pakistan economy achieve its
targeting goals more efficiently.

2.2 Empirical Background:

Macroeconomic theory assumes that Non Stability of Money Demand cause

inflation. Although a number of empirical research proved a Brought
relationship b/w inflation and Monetary Policy. In the View of (Akhtar,
2006)that, Empirical evidence shows a time lags of 6 to 24 months of impact on
Aggregate Demand due to transmission of Monetary Policy.
Literature Review Investigates in Research Bulletin of State Bank of Pakistan
(Moinuddin, 2009) that, from 2009 Pakistani Policy Maker is more concentrates
for the evaluating of Inflation targeting regime and Money demand because the
inflation rate of 2009-10 is 11.17%.

(khalid, Winter 2005) that including Pakistan the optimal rate of inflation for
developed and industrialized countries up to 1– 3% and in Developing
countries (Including Pakistan) the inflation rate is 7 – 11%.

A number of researchers in Pakistan have attempted overtime by (Malik &

ahmed, 2008) studies show that monetary factors especially non stability of
Money Demand play a dominant role in the long run inflation, and in short
run other factor such as food prices also effect the inflation.
3:Model Frame Work

Our primary objective is to check the impact of money supply and inflation on
Pakistan National Income GDP. We use the multi regression to desire the
results. We used annual data from the year 2000 to 2009 and make 9
observations to find out the relation. Regarding this we take GDP as a
dependent variable and Inflation and money supply as independent variable.. So
the function which is generated to find out the result is,
GDP = α + β INF + β MS + µ
Where;
INF: Inflation
MS: Money Supply
GDP: Gross Domestic Product

4:Estimation and Result

The model consists of three variables, where the Gross Domestic Product (GDP)
is dependent variable and Inflation (INF), and Money Supply (MS) is independent
variable. The data from which the result is obtained is Economic Survey of
Pakistan 2009-10.

Correlations

GDP Inflation money supply

GDP Pearson Correlation 1 -.170 .028
Sig. (2-tailed) .662 .943
N 9 9 9
Inflation Pearson Correlation -.170 1 .965(**)
Sig. (2-tailed) .662 .000
N 9 9 9
money supply Pearson Correlation .028 .965(**) 1
Sig. (2-tailed) .943 .000
N 9 9 9
** Correlation is significant at the 0.01 level (2-tailed).

The above table show between relation between GDP and INF is negative -0.170, and
in significant 0.662 and between GDP and MS is positive 0.28 and in significant 0.943.
 Regression Analysis

Now we use the multi regression and transform data in log form because the
remove the auto correlation in data .So the function is generate in new form.

GDP (log) = α + β INF (log) + β MS (log) + µ

Model Summaryb

Change Statistics
Adjus ted Std. Error of R Square Durbin-
Model R R Square R Square the Estimate Change F Change df1 df2 Sig. F Change Wats on
1 .904a .818 .757 .01390 .818 13.489 2 6 .006 2.047
a. Predictors : (Cons tant), logms , loginfl
b. Dependent Variable: loggdp

The above table show

1.Value of R=0.904 mean show that the accuracy of relation between the all
variable.
2. Adjusted R2 also show the accuracy of the all variable that is R2 =0.757
3. Std Error Show the allow error in Estimation the Value of Std Error =0.01390
4.Durbin Watson Value =2.047 show that negative auto correlation in variable
but its nearly 2.0 .we know that when Durban Watson show value is 2.0 its
mean no auto correlation.

Coefficients (a)

Unstandardized Standardized 95% Confidence Interval for

Model Coefficients Coefficients t Sig. B

B Std. Error Beta Lower Bound Upper Bound

1 (Constant) 5.460 .182 30.010 .000 5.015 5.905
loginfl -.376 .074 -2.913 -5.083 .002 -.558 -.195
logms .193 .037 2.961 5.167 .002 .102 .285
a Dependent Variable: loggdp

Now we make Equation show the constant and coefficient value.

GDP(log) = 5.460 -0.376 INF(log) + 0.193 MS(log) + µ
T Value = -5.083,-5.167.
Confidence interval also show the significant impact of independent variable
(Between range no zero lie)
Result shows (having P-Value <0.05) that both inflation and money supply have
significant impact on GPD and they cannot be ignored.
 Residuals Statistics(a)

Minimum Maximum Mean Std. Deviation N

Predicted Value
4.6065 4.6749 4.6502 .02552 9
Residual
-.01856 .02049 .00000 .01204 9
Std. Predicted Value
-1.713 .969 .000 1.000 9
Std. Residual
-1.335 1.475 .000 .866 9

a Dependent Variable: loggdp

5: Conclusions

The results from the Regression Analysis indicate that there is strong Impact

money supply and inflation on the GDP.

The Most important conclusion that emerged from the analysis is that the money

supply growth has been an important contributor to the rise in inflation in

Pakistan. This is to conclude that inflation in Pakistan is a monetary

phenomenon. This may be due to multiple changes and loose monetary policy

adopted by the State Bank of Pakistan and the Policy Makers of Pakistan to

boast the high priority of the growth objective. It is argued that the policies to

boast output growth through money supply only have short run effect on real

output but generate inflation.

References
A. Q. (2006). Money, Inflation and Growth in Pakistan. The Pakistan Development Review, 45 : 2,
203-212.

Akhtar, S. (2006). Pakistan Monetary Policy Developments. BIS Review , 55.

Khalid, a. M. (Winter 2005). economic growth, Inflation and Monetary Policy In pakistan
Premilinary Emperical Estimates. the Pakistan Development Review, 44.4 Part II, 961-974.

Malik, W. s., & ahmed, a. m. (2008). Monetary Policy Reaction Function In pakistan.

Moinuddin. (2009). Choices of Monetary Policy Regime, Should the SBP Adopt inflation
targeting? SBP Research bulliten, 5.