Testing the Link between Inflation and Economic Growth: Evidence from Asia

The link between inflation and economic growth is one of the most important controversies in the economic literature. This paper investigates the short-run and the long-run relationship between the economic growth and the inflation of three Asian courtiers over the period 1980-2010. The methodology used in the study is cointegration and causality test. Johansen’s cointegration test and bound test approach were performed on the variables which have been tested for the stationary property using Augmented Dickey-Fuller and Phillips and Perron tests in order to examine the cointegration between the economic growth and the inflation. Vector error correction and Granger Causality test were further performed to discover the short run dynamics of the relationship between the variables and identify the direction of causality. The results reveal that there is a long run negative and significant relationship between the economic growth and inflation in Sri Lanka. Whereas no statistically significant relationships were found between the variables in China and in India, a negative and significant short run relationship was found for China. The causality results reveal that there is a unidirectional causality that runs from the economic growth to the inflation in China. The paper discusses the important policy implications of the results.