Exploring Macroeconomic Determinants of Inflation in Pakistan; Fresh Insights from Vector Autoregressive Analysis

Abstract

It is a widespread argument that mild inflation is in favor of the economic growth of an economy. However, high inflation can be destructive to consumers as well as to businesses and the overall economy. Hence, identifying essential sources of inflation is crucial for both the central bank and economic units. The purpose of this study, therefore, is to examine the key determinants of inflation in Pakistan by using time series data over the period extending from July 1993 to May 2021 and employing the Vector Autoregressive (VAR) method. The variables are seasonally adjusted while growth rates of all the variables are used except for the interest rate in the study. The model results revealed that global crude oil prices, imports, money supply, and government borrowing are the most important determinants of inflation in Pakistan. Furthermore, the findings also showed that the exchange rate and interest rate have a positive effect on inflation and are statistically significant. Based on the findings, the study recommended that inflation may be kept under control by taking the following measures such as controlling government borrowings, money supply, and particularly, imports. Additionally, regulating exports and interest rates can also help in combating the problem of inflation.