Email: nafees_swat@hotmail.

com
CHAPTER 01
INTRODUCTION
Introduction
The main focus of our study is to determine the different aspects of inflation in Pakistan
from local and global perspective. Pakistan achieves an extraordinary economic growth
and poverty decline from the first ! years of its independence among the developing
countries. "n the late #$%! Pakistan &'P growth rate was ( percent per annum and
poverty rate was lowered to #% percent. 'ue to large population the inflation rate was
critically low. "n #$$! the economy of Pakistan was inverted and it was not a good period
for the economy. The level of inflation starts to raise) poverty level increased to **
percent and growth rate becomes lowered.
The high inflation over the last +! years in Pakistan had been unpredictable. This is
because of decelerating economic growth) output set,backs) loose monetary policies)
higher duties and taxes) political instability) a depreciating Pak rupees and fre-uently
ad.ustments in the administered prices of gas) electricity) P/0 products as well as the
support prices of wheat. The basic ob.ectives of the study are the attempt to analy1e
the factors of inflation in Pakistan. The following are the basic ob.ectives of the study.
Page #
1.2. OBJECTIVES OF STUDY
The ob.ective of study is to test how inflation is effected by 2oney 3upply and "nterest
4ate in Pakistan. This includes:
i. To show the short,term and long term relationship between the variables
ii. To identify the appropriate and ma.or model of inflation for Pakistan
iii. To imply policy makers for solving the dilemma of inflation in Pakistan.
#.*. R!"rc# $u!tion
%"in $u!tion
5hat is the relationship between "nflation) 2oney 3upply and "nterest 4ate6
Su& $u!tion!
4elationship between "nflation and 2oney 3upply
4elationship between "nflation and "nterest 4ate
1.'. HYPOTHESIS OF STUDY
7
8
: There is no relationship between "nflation) 2oney 3upply) &'P &rowth and "nterest 4ate
7# : There is relationship between "nflation) 2oney 3upply) &'P &rowth and "nterest 4ate)
Page +
1.(. I%PORTANCE OF THE STUDY
This study determines the strong relationship between inflation 2oney 3upply and "nterest
4ate in Pakistan
This study shows the important factors that 2oney 3upply contributes in rise of "nflation
because of loose monetary policy of 3tate 9ank of Pakistan
The study of money supply) interest rate and inflation will help the policy makers to
review the monetary policy and to control the effect of inflation on the economy
This study shows that inflation has great impact on the poor segment of society and low
"ncome people

Page *
C#")tr * 2
+ITERATURE REVIE,
"nflation) 2oney supply and interest rate are the most important factors of the economy
and it needs greater importance from the authorities. The writers have given different
views regarding these issues which are as follows.
2eenai :#$((; noted that the circulation of currency and 9ank deposits is involved in
2oney 3upply. The government and private sectors are the two main important factors
that bring changes in 2oney 3upply. 5hen loan from commercial banks and 3tate bank
increases or decreases will bring changes in 2oney 3upply. <ny changes in 3tate 9ank
holdings of &old and foreign reserves will bring changes in 2oney 3upply. <ll these
factors can be controlled by controlling the foreign exchange reserves) credit to private
sectors and government sectors.
0indauer :#$(%; observed that inflation is the raise in the price level of an economy=s
prices that bring changes in a production level of goods and services by keeping the
money income fixed and falling the purchasing power of consumers. "nflation affects the
production level of an economy and the purchase of those things whose prices rise due to
inflation. "nflation reduces the prices of bonds and saving level of people. The purchasing
of commodities in an inflationary economy is more expansive while it less expansive in
Page
other economy so the consumer will move to that economy where the prices are low. "t
clearly shows that inflation is an evil for the economy.
>airn >ross :#$?@; observed the relationship of inflation and money supply. 5hen
money supply increases in an economy then there is increase in the prices which bring
inflation and vice versa. 3ometimes inflation occurs due to oil prices. The government
blame that the importing countries increase the oil prices which is the signal for inflation.
3ometimes the government increases the taxes and tariffs which create an opportunity for
deflation and inflation. The value of money sometimes decreases due to natural disaster)
harvest failure or in a situation of war) which creates a possibility for inflation.
7arberler :#$?@; observed that the monetary phenomenon is not the only factor but there
are various factors which affect the inflation that is the pressure of labor union on wages)
government credits and monopoly. "f labor union pressure is the main cause of inflation
then we will use fiscal policies to put pressure on the authorities of monetary policies to
achieve e-uilibrium in inflation to control labor union pressure.
<ccording to harberler monopoly and labor union are the most important factors
of inflation. 2onopolist increase the prices of their specific products while labor union
put pressure on increasing wages while production remains constant thus cause the
inflation. "ncreasing money supply in an economy results in increase in the level of
inflation so) in this situation fiscal policies are used to control the evil of inflation.
3taats :#$%+; explore the concept of money supply and mentioned that stock of money is
Page @
important for the economy. The rate at which money supply circulates in the economy is
important because it affect the rate of economic activities. The permanent definition of
money supply does not exist but there are different types of financial assets which are
used as a part of definition. The different types of money are 2
#
) 2
+
and 2
*.
2# is the
most important part of money supply which includes currency in circulation) deposits and
bank=s demand deposits.
3hilling and 3okoloff :#$%*; indicate the signs of inflation. the first sign is that the new
buyers cause to rise inflation in securities business and take it to the peak. 3econdly
inflation occurs due to speculation. Thirdly the money borrowed for speculation also
turns a cause of inflation. Price advance in investment can also a cause of peak inflation.
7e indicates that inflation severely occurs when money is drawn from an assets
investment to the speculation purpose. 7e indicates that inflation rises one may see the
volume of trade to be increased in speculation instead of normal investment. 7e noted
that when a frantic search is looked for speculation resulting inflation occurs in the
market. 7e further mentioned that inflation takes place when the basic fundamentals are
tried to change. 7e indicates that inflation can be seen by market action. The good index
when usually shows a price hike. The last sign is when it is expected that inflation would
continue for a long time in future can cause a sever inflation.
9urstein :#$%(; discussed inflation and money supply and removed the confusion
between money and credits. 7e explains that due to the reflux principle the demand
function for credit are debt repayment) money supply and its growth. "ncrease in credit
Page (
demand will lead to growth in money and temporary rise in money supply may be
deducted from debt reimbursement. 7e said that money supply and inflation are
correlated. The correlation between inflation and money supply is important thing. 7e
explained that rate of growth is less than inflation rate then there will be decrease in real
stock of money.
7ale and 7anon :#$$!; observed that the money supply should be controlled and it is
very important issue. 7e concluded that demand level in the economy can de control by
controlling the money supply. "t has a greater importance in monetarist government and
they use different tools for measuring the money supply. The uses different types of
money i.e 2
!
) 2
#)
2
+
for measuring. There are different ways for controlling the inflation
rate which affect the level of demand. There should tightened monetary and fiscal
policies to reduce the level of demand in the economy. The government should reduced
their spending) they should increase the tax will decrease the total demand. The inflation
rate can also be control by exchange rate.
3hapiro :#$$+; noted that due to inflation some people of the society affect badly and
some people get advantage from it. The price level changes due to inflation which affects
the economic rate of growth. 'ue to this the rich people become richer and poor people
become poorer. 3ometimes it has an adverse affect on high level income people because
of unknown factors. <uthors explain the affects of inflation and also explain the different
procedures of controlling it by using fiscal and monetary policy. Aiscal and monetary
policies are use to control the evil of inflation but there need a great care of using these
Page ?
policies because inflation is of different types) some of the inflation is demand side
inflation and the other is supply side inflation so the fiscal and monetary policies don=t
match with supply side inflation ."f fiscal policy is used it will affect little and will
reduced inflation.
9rono and Easterlty :#$$(; explained that at the annual rate of inflation less than !B
there is no association between inflation and growth. They found negative or medium
type association during high inflation. They report that due to high inflation crises there
were no damage to growth because the countries recover their position which was before
the crises.
&hosh and Phillips :#$$%; using large time series of data and found that at very low
inflation rate of +,* percent there is strong association between inflation and growth and
negative association at high inflation rate.
3hahid :+!!; explained the behavior of money supply as it is determined by central bank
and commercial banks. To understand the money supply he considers the collective
behavior of &overment) commercial banks and central bank. The commercial take money
from the central and public banks and lend this money to the people) governments and
investors and put a certain proportion of demand deposits and time. "t will help in the
determination of money supply.
Cinghan :+!!@; explain the various types of money supply. 2#is the narrow type of
money which include currency in circulation) deposits in state bank and bank demand
Page %
deposits.2+ is a broad money and 2* includes 2+ and bank time deposits but 2* is not
satisfactory and it does not use as medium of exchange and cannot perform the function
of money. 7e said that inflation is a monetary phenomenon. 3ome economists believe
that money supply is not the only factor of inflation but there are other factors like
increase in public expenditure) financing deficit) natural disaster) existing of black market
and expansion of private sectors etc.
<bdul Dayum :+!!(; >oncluded that the rise in prices is due to the excess of 2oney 3upply)
growth in velocity E real income. 7e furthers indicated that there is positive relationship
between money growth E inflation. The money supply growth affect the real &'P E inflation)
this is due to the loose monetary policy of the central bank of Pakistan.
Theoretical Aramework
"nflation is defined and categori1ed on the basis of various factors that can cause inflation.
"nflation is a burning issue in present period across the world. Every economy is trying to control
it for a better result. 5e may control inflation by adopting various techni-ues. The different
studies and researches have been conducted by the economists and researchers to control the
inflation) and they have also concluded various strategies) methodologies and techni-ues to
describe the effect of inflation. They explore a relationship between the two or more variable and
define independent variables and further discuss the variable which generally cause inflation in a
country.

Page $
D-"nd Pu.. T#or/
"t is the type of inflation in which demand of the consumer is increases in the country. 5hen
many consumers trying to purchase the same goods the demand of that goods increases due to
which price increases if the supply of that product is lacking. 5hen this occurs across the whole
economy for all goods is known as demand pull inflation. The causes of the demand pull
inflation in Pakistan is the 2oney 3upply because 2oney 3upply in the economy increases and
consumers have a purchasing power to buy the product.
< famous economist said that F itGs also shown that
2oney growth has positive and lasting effects on inflation but possibly will affect output only in
the short run or in the long run. 2oney is probably neutral. H
Co!t Pu!# In0."tion
"t is the type of inflation in which cost of production of important goods and services is
increases where there is no alternative is available. "t consist of cost of wages) raw material)
factory overhead) administrative and selling expanses. 5hen the cost of production increases
there is increase in prices of goods and services.
Page #!
Theoretical Aramework
"n this study an attempt was made to show the effect of "nterest 4ate and 2oney 3upply on
"nflation. "n this study "nterest 4ate and 2oney 3upply are independent variables and inflation is
dependent variable.
D)ndnt V"ri"&.
"nflation
Independent Variables
2oney 3upply
"nterest 4ate
Page ##
"nflation
2oney 3upply
"nterest 4ate
CHAPTER 01
DATA %ETHODO+O2Y
T/) o0 R!"rc#: 'escriptive) Empirical) Dualitative and explanatory.
S"-).: #$$!,+!#!
Sourc o0 d"t": 3econdary data is used in the study which is taken from the publication of
"nternational 2onetary Aund :"2A;) publication of economics surveys of Pakistan and the website of
3tate 9ank of Pakistan.
%od.: "IAt J K8 LK#23t L K+&&'Pt L K*"4t L M
t

D0inition o0 3"ri"&.!:
In0."tion:
FThe increase in the general price level of goods and services over a period of timeH
%on/ !u))./:
F 2oney 3upply is the total amount of money circulated in an economy at a particular point of time.
H
Intr!t R"t:
"nterest rate is the surplus money on the total money. The amount charge from
customers for their services "t is usually calculated as an annual basis.
Page #+
D"t" %t#odo.o4/
The Nariables which are used for study are "nflation) 2oney supply and "nterest 4ate.
"nflation :'ependent Nariable;
3ymbol Osed: "nflation :"IA;
2oney 3upply :"ndependent Nariable;
3ymbol Osed: 2oney 3upply :23;
"nterest 4ate :"ndependent Nariable;
3ymbol Osed: "nterest 4ate :"4;
This study describes the regression and correlation and relationship between G"nflation and
2oney 3upplyG and G"nflation and "nterest 4ateG in Pakistan in long run as well as in short run.
3o) in the study the "nterest 4ate used as the independent Nariables. Aor the research the annual
data will be used on "nflation) 2oney 3upply and "nterest 4ate for the period of #$$! to +!#!.
<s the purpose of the study is to investigate the correlation relationship between G"nflation
and 2oney 3upplyG and G"nflation and "nterest 4ateG in Pakistan in long run so we collect annual
data from #$$! to +!#! from Pakistan for the research. 5e used the data of +! years as we
want to investigate the macroeconomics impact of 2oney 3upply and "nterest 4ate on
"nflation.
Page #*
%t#odo.o4/
St"tion"r/ )roc!!
< stationary has constant mean and variance but covariance difference must be same
between two times period. 5e cannot get consistent estimators without it.
"t will be checked that the series of data are stationary or not6 To test the stationary property of
all the data series) the augmented 'ickey,Auller :<'A; test and Philips,Perron test will be used. "n
an econometrics) an augmented 'ickey,Auller test :<'A; is a test used to make non stationary time
series data into stationary data.
T!tin4 Procdur
The following are the <'A testing procedure.
P "IAt J K8LQ#"IAt,# L K#t LRP"IAt,# L R+ P "IAt,+ LSS.LRpP"IAt,T L Mt
5here P "IAt J "IAt , "IAt,#
P 23T J K8 LQ+23t,# L K+t LR#P23t,# L R+P23t,+ LSS.. L RP P 23t,p L Mt
5here P 23T J 23t U 23t,#
P"4T J K8 LQ"4t,# L Kt L R#P"4t,# L R+ P"4t,+LSS.L RpP"4t,pL Mt
5here P "4T J "4t U "4t,#
5here)
K8 J shows the constant
R J shows the parameter
Page #
T J shows the lag order
The following hypothesis will be checked by <'A test.
Aor checking the stationary Property in time series of "nflation.
7ypothesis #
7 8 : "IAt is a non,stationary) Q# J !.
7 # : "IAt is stationary) Q# V !
7ypothesis + for checking the series of 2oney 3upply :23t;
7 ! : 23t is non,stationary) Q+ J /
7 # : 23t is stationary) Q+ V /
7ypothesis * for checking the series of "nterest 4ate :"4t ;
7 ! : "4t is non,stationary) Q J /
7 # : "4t is stationary) Q V /
Page #@
Dci!ion ru.5
"f p , value W @B tabulated value) X not re.ect null hypothesis) i.e. unit root exists.
"f p , value V @B tabulated value) X re.ect null hypothesis) i.e. unit root does not exist.
Si-). Co6Int4r!!ion An"./!i!
5hen the time series data are non, stationary) the simple co integration test will be
conducted between "nflation and 2oney 3upply and "nflation and "nterest 4ate individually and
the scatter diagramY line diagram will be drawn for checking the relationship between "nflation
and 2oney 3upply and "nflation and "nterest 4ate respectively.
The 3imple estimation e-uation for "nflation and 2oney 3upply is given as
"IAt J R LK#23t L Mt
The 3imple estimation e-uation for "nflation and "nterest 4ate is given as
"IAt J R LK*"4t L Mt
Corr."tion :
The correlation is one of the important and useful statistics. < correlation is a single number
that explain the level of relationship between two variables. The correlation test will be perform
to check the correlation relationship between "nflation and 2oney 3upply) "nflation and "nterest
4ate.
T!t o0 2oodn!! o0 Fit "nd Corr."tion5
5e will test the overall explanatory variables of the whole regressionZ this is done by
calculating the coefficient of determination and is generally denoted by 4
+
.The coefficient of
determination :4
+
; measure the proportion of the total variation in dependent variable
Page #(
describe by the regression model. "n my study the 4
2
will measure that how much of the
variations in the "nflation in Pakistan at long run is describe by the variation in 2oney 3upply
and "nterest 4ate correspondingly in Pakistan at long run.

Explained Nariation in "nflation :"IAt;
R
2
=
Total Nariation in "nflation (INFt)
[ (INF - INF)
2
R
2
=
(INF INF)
2
The s-uare root of the coefficient of determination (4
2
) in the 3imple regression analysis is
the total value of the coefficient of correlation) which is denoted by 4. That is)
4J
<bsolute
This is simply to evaluate the degree of relation or co variation that exists between variables
"nflation and 2oney 3upply) and "nflation and "nterest 4ate.
Co6int4r"tion t!t5
>o integration is the procedure for testing the co Uintegration of time series.5hen two or
more than two series are not stationary and if their linear combination is stationary then this
Page #?
type of series are said to be co,integrated. This test is more applicable than Engle U &ranger
test which shows the short run relationship between variables and if there is no co,
integration then Error >orrection 2odel will be used to show the long run relationship
between variables.
The two main methods for testing for cointegration are:
#. The Engle,&ranger method.
+. The Cohansen co,integration test.
"n the study) the Cohnson co,integration test is used to check the co integration between variables.
Co6int4r"tion t!t 0or In0."tion "nd %on3 Su))./ "r "! 0o..o7!5
"IAit J K8LKi23.t L M
t
5here) " J #)+)*))..S.
H/)ot#!i!
78: There is no co integration is present between "nflation and 2oney 3upply :23t; at the
significance level in Pakistan) K J !
7#: There is co integration is present between "nflation and 2oney 3upply :23t; at the
significance level in Pakistan) K\ !
Iow the trace statistics will be used for testing the above hypothesis.
"f the trace value is greater than the tabulated value which indicates that there is a long run
relationship between "nflation and 2oney 3upply
Page #%
Error corrction -od. 8EC%9
The E>2 will be run with the data at level from as well as at "
st
difference form also.
+on4 run r."tion!#i)
H/)ot#!i!
7/J There is no relationship exist between "nflation and 2oney 3upply in Pakistan in long run
at the significant level) K J !
7#J There is relationship exists between "nflation and 2oney 3upply in Pakistan in long run at
the significant level) K \ !
The A,test and t,test will be used for testing the above hypothesis.
S#ort run r."tion!#i)
H/)ot#!i!
78J There is no relationship exist between "nflation and 2oney 3upply in Pakistan in short
run at the significant level) K J !
7#J There is relationship exists between "nflation and 2oney 3upply in Pakistan in short run at
the significant level) K \ !
T6St"ti!tic!
<fter an evaluation of a coefficient) the t,statistics for that coefficient is the proportion
of the coefficient to its standard error. "t can be tested against at distribution to findout how
feasible it is that the coefficient value is truly 1ero. "t can be defined by the following e-u-tion
Page #$
T J ]:"IAt , 23t; , d^ Y 3E.
An"./!i! o0 V"ri"nc
"t can be used to test the explanatory powers of the whole regression. The A statistics is used to
check the hypothesis that how much significant proportion of the change in the dependent
variable is explained by the change in independent variable. Aor this purpose the A statistics is
used to test the null hypothesis that all the regression coefficient are e-ual to 1ero against the
alternative hypothesis which is not e-uall to 1ero.
The value of the A statistic is given by
A J Explained variation Y :k , #;
Total variationY :n , k;
5here) n shows the number of observation and k shows the number of parameters. "t is because
the A statistics test is the ratio of two variances therefore this test is often referred to as the
analysis of variance. "t will determine the A statistics in terms of the coefficient of determination
as follows:
4
+
Y:k,l;
A J :" ,4
+
;Y:n,k;
7ere 4
+
shows the coefficient of determination between "nflation and 2oney 3upply in
Pakistan in long run. <fter this we will compare the calculated value of the A statistics with a
tabulated value taken from the table of the A distribution. "f the calculated value of the A
statistics is greater the tabulated value of A distribution the null hypothesis is re.ected as
Page +!
there is no relationship between "nflation and 2oney 3upply in Pakistan in long run) and
the alternative hypothesis is accepted that not all the coefficient e-ual to 1ero) and vice versa at
@B significant level.
Co6int4r"tion t!t 0or In0."tion "nd Intr!t R"t
"IAit J K8 LKi"4 L Mt
5here) iJ#)+)*))@) (SS
H/)ot#!i!
78: There is no co integration is exists between "nflation and "nterest 4ate at the significance
level in Pakistan) K J !
7#: There is co integration is exists between "nflation and "nterest 4ate at the significance level in
Pakistan) K \ !
Iow for testing the above hypothesis the trace statistics will be used
Then if there is no co integration exists between "nflation and "nterest 4ate) the &ranger
>ausality test will be used to indicate the short run relationship between "nflation and
"nterest 4ate) while if there is co integration exists between "nflation and "nterest 4ate at
significance level then the E>2 will be used between "nflation and "nterest 4ate) so that the
result about both short run and long run relationship can be achieved.
Page +#
Error corrction -od. 8EC%9
The E>2 will be run with the data at level from as well as at "
st
difference form also.
+on4 run r."tion!#i)
7ypothesis
7/J There is no relationship exist between "nflation and "nterest 4ate in Pakistan in long run at
the significant level) K J !
7#J There is relationship exists between "nflation and "nterest 4ate in Pakistan in long run at
the significant level) K \ !
Iow for testing the above hypothesis the trace statistics will be used.
S#ort run r."tion!#i)
H/)ot#!i!
7/J There is no relationship exist between "nflation and "nterest 4ate in Pakistan in short run at
the significant level) K J !
7#J There is relationship exists between "nflation and "nterest 4ate in Pakistan in short run at
the significant level) K \ !
T,3tatistics
<fter an evaluation of a coefficient) the t,statistics for that coefficient is the proportion
of the coefficient to its standard error. "t is calculated as
T J ]:"IAt , 4Tt; , d^ Y 3E.
Page ++
F6 T!t "nd An"./!i! o0 V"ri"nc
The A statistic is used to show that the model is statistically stable. The value of the A statistic is
given by
A J Explained variation Y :k , #;
Total variationY :n , k;
5here) n shows the number of observation and k shows the number of parameters."t is because
the A statistics test is the ratio of two variances therefore this test is often referred to as the
analysis of variance. " will determine the A statistics in terms of the coefficient of determination
as follows:
A J 4
+
Y:k,l;
:" ,4
+
;Y:n,k;
7ere 4
+
shows the coefficient of determination between "nflation and "nterest 4ate in
Pakistan in long run. <fter this we will compare the calculated value of the A statistics with a
tabulated value taken from the table of the A distribution. "f the calculated value of the A
statistics is greater the tabulated value of A distribution the null hypothesis is re.ected as
there is no relationship between "nflation and "nterest 4ate in Pakistan in long run) and the
alternative hypothesis is accepted that not all the coefficient e-ual to 1ero) and vice versa at @B
significant level.
Page +*
%u.ti coint4r"tion An"./!i!
T# %u.ti co6int4r"tion %od.
The multi co,integration model will be used for testing the co,integration between
"nflation) 2oney supply and "nterest 4ate.
"IAt J Ko L K#23t L K+"4t L M
t
"IA is dependent variable while 23 and "4 are the explanatory variables. M
t
is the error
term that affect the "nflation in Pakistan and we will .ust test that how much changes in 2oney
3upply and "nterest 4ate.
The values of Ko) K#) K+)4
+
and ad.usted 4
+
will be calculated and at end we will use A
statistics to check the hypothesis that the variation in the 2oney 3upply and "nterest 4ate
explains a significant proportion of the variation in the "nflation.
Coint4r"tion T!t
H/)ot#!i!
78: There is no co,integration exist between "nflation) 2oney 3upply and "nterest 4ate at
significance level in Pakistan) K J !
7#: There is cointegration is exists between "nflation) 2oney 3upply and "nterest 4ate at the
significance level in Pakistan)K\!
Iow for testing the above hypothesis the trace statistics will be used.
Page +
Error Corrction %od. 8EC%9
The E>2 model will be used to find out the effects of changes in 2oney 3upply and "nterest
4ate on "nflation in Pakistan and to check that whether 2oney 3upply and "nterest 4ate
explains significant changes of "nflation or nor6 "s yes) then how much6
H/)ot#!i!
78: The 2oney 3upply and "nterest 4ate combine do not describe a significance proportion of the
changes in "nflation in Pakistan in long run) K J !
7#: The 2oney 3upply and "nterest 4ate combine describe a significance proportion of
the changes in "nflation in Pakistan in long run) K \ !
A statistics will be used for testing the above hypothesis
A J 4
+
Y:k,l;
:",4
+
;Y:n,k;
7ere 4
+
shows the coefficient of determination between "nflation) 2oney 3upply and
"nterest 4ate in Pakistan in long run. <fter this we will compare the calculated value of the A
statistics with a tabulated value taken from a table. "f the calculated value of the A statistics is
greater than tabulated value of A distribution the null hypothesis is re.ected as there is no
relationship between "nflation) 2oney 3upply and "nterest 4ate in Pakistan in long run) and
the alternative hypothesis is accepted that not all the coefficient e-ual to 1ero) and vice versa at
@B significant level.
:
Page +@
CHAPTER 0'
E-)iric". An"./!i!
This chapter include the analysis and its results. "t include the descriptive statistics) <ugmented
'ucky,Auller test for "nflation) 2oney supply and interest rate) the correlation test the Cohnson
co,integration test and Error >orrection 2odel test and their interpretations.
T"&. '.1 D!cri)ti3 St"ti!tic!5
V"r N %in %"; %"n Std. D3
"IA
+# #.$! +#.@! $.(#$ .?%%%$
23
+# *#.+! @???.+! +.!@@!E* #((!.!+$@#
"4
+# ?.@! +!.!! #+.#@+ *.(?*+*
INF: inflation, MS: money supply, IR: interest rate, Min: minimum value, Ma
: maimum value, st!" #ev: stan!ar! !eviation"
The table .# describes the statistics of the findings. The dependent and independent variables
are shown in the first column and different statistics are shown in the rows. I represents the
number of observation which is +#.
"n my study the 2ean and 3td. 'eviation of inflation are $.(#$ and .?%%%$ respectively and
#.$! is the minimum and +#.@! is the maximum mean value similarly the mean and std.
Page +(
deviation of money supply are +.!@@!E* and #((!.!+$@# respectively and *#.+! is the
minimum and *#.+! is max mean value. The mean and 3td. deviation of "nterest rate are
#+.#@+ and *.(?*+* respectively and the minimum value of its mean is ?.@! and maximum is
+!.!!.
Unit root t!t5
<ugmented 'ickey Auller test is used to see that the data is stationary or not on the level) #st
difference and +nd difference. "nflation and "nterest 4ate are stationary in #
st
difference level and
2oney 3upply is stationary on +
nd
difference level.
Au4-ntd dic</ 0u..r t!t
In0."tion
T"&. '.2 In0."tion
t,3tatistics Probability
Test statistics ,(.+%*@ (.+!#e,!!@
Tabulated values #B level ,*.?@+$
@B level ,+.$$%!
#!B level ,+.(*%?
ProbZ stands for p,value,statistics for tau,value) tabulated value are taken from the table
5e apply <ugmented 'ickey Auller test to check the stationarity property of inflation at level)
"
st
difference and +
nd
difference therefore the data of "nflation is stationary on #
st
difference at
#B significance level as the <ugmented 'ickey,Auller t,statistic value :(.+%*@$; is greater
than the tabulated value at #B level :*.?@+$(;. The null hypothesis will be re.ected in the
support of alternative hypothesis because the P value is less than :!.!@; which tell us that the
series of inflation is stationary and unit root does not exists.
Page +?
%on/ Su))./
T"&. '.1 %on/ Su))./
t,3tatistics Probability
Test statistics ,@.!(+ !.!!!%(
Tabulated values #B level ,*.?@+$
@B level ,+.$$%!
#!B level ,+.(*%?
ProbZ stands for p,value.t,statistics for tau,value) tabulated values are taken from the table
5e apply <ugmented 'ickey Auller test to check the stationarity property of 2oney 3upply at
level) "
st
difference and +
nd
difference therefore the data of 2oney 3upply is stationary on
#
st
difference at #B significance level as the <ugmented 'ickey,Auller t,statistic
value:@.!(+@; is greater than the tabulated value at #B level :*.?@+$(;. 5e re.ect the null
hypothesis in support of alternative hypothesis because the P value is less than :!.!@; which tell
us that the series of 2oney 3upply is stationary and there is no unit root exists.
Intr!t R"t
T"&. '.' Intr!t r"t
t,3tatistics Probability
Test statistics ,*.(*$? !.!#%
Tabulated values #B level ,*.?@+$
@B level ,+.$$%!
#!B level ,+.(*%?
ProbZ stands for p,value,statistics for tau,value) tabulated value are taken from the table
Page +%
5e apply <ugmented 'ickey Auller test to check the stationary property of "nterest 4ate at
level) #
st
difference and +
nd
difference therefore the data of "nterest 4ate is stationary on
#
st
difference at @B significance level as the <ugmented 'ickey,Auller t,statistic value :*.(*$?;
is greater than tabulated value at @B level :,+.$$%!(;. 5e re.ect the null hypothesis in support
of alternative hypothesis because the P value is less than :!.!@; which tells us that the series of
"nterest 4ate is stationary and there is no unit root exists.
T"&. '.( Corr."tion!
< correlation explains the level of relationship between two variables. The
correlation test will be done to check the correlation relationship between "nflation
and 2oney 3upply) "nflation and "nterest 4ate.
"IA: "nflation) 23: 2oney 3upply) "4: "nterest 4ate
"n this table "IA represent "nflation) 23 represent the 2oney 3upply and "4 represent the
"nterest 4ate. 7ere "nflation is dependent variable 2oney 3upply and "nterest 4ate are
independent variables. Table .@ shows that there exists a strong positive correlation between
"nflation and 2oney 3upply and "nterest 4ate. The value .#$# shows that there is positive
correlation between "nflation and 2oney 3upply and .*?? shows that there is positive correlation
Page +$
"IA 23 "4
"IA #
23 .#$# #
"4 .*?* .!%# #
between "nflation and "nterest 4ate but ,.!%# shows that "nterest 4ate and 2oney 3upply has a
negative correlation as shown above
Jo#"n!n Co6int4r"tion T!t5
Co6int4r"tion5
>o integration is the procedure for testing the coUintegration of time series. 5hen two or
more than two series are not stationary and if their linear combination is stationary then this
type of series are said to be co,integrated. This test is more applicable than Engle U &ranger
test which shows the short run relationship between variables and if there is no co,
integration then Error >orrection 2odel will be used to show the long run relationship
between variables.
Co6int4r"tion T!t 0or %on/ Su))./= Intr!t R"t "nd In0."tion5
3ample :ad.usted;: #$$! +!#!
"ncluded observations: +! after ad.ustments
3eries: 23 "IA "4
0ags interval first differences;: " to "
T"&. '.> co6int4r"tion
7ypothesi1ed
Io. of >E:s;
Eigen value Trace 3tatistic Tabulated Nalue
!.!@
Probability__
Ione _ !.%**(# (.*%+ +$.?$? !.!!!@
<t most " _ !.?*%#? *+.#!! #@.$ !.!!!?
<t most + _ !.*@%!% ?.$?$* *.%# !.!!?
__2ac`innon,7aug,2ichelins :#$$$; p,values
"IAt J K
o
L K#23t L K+"4t L M)
Page *!
5here) " J #)+)*))@S..
78: There is no co integration is present between "nflation) 2oney 3upply and "nterest 4ate
atthe significance level in Pakistan) K J !
Nersus 7#: There is co integration is present between "nflation) 2oney 3upply and "nterest 4ate
at the significance level in Pakistan) K \ !
Aor testing the above hypothesis we will use the trace statistics
The above analysis shows that the trace value is larger than the tabulated value which indicates
that there is a long run relationship between "nflation) 2oney 3upply and "nterest 4ate.
The co integration test shows that there are three co,integration e-uations and accept the
alternative hypothesis and re.ect the null hypothesis at !.!@ level of significance as shown
Error Corrction %od.5 :E>2;
'ependent Nariable: :"IA;
2ethod: 0east 3-uares
3ample: #$$! +!#!
Io of observations: +!
T"&. '.? EC%
Nariable >oefficient 3td. Error t,3tatistic Prob.
> ,*.!(@%( #.@+$! ,+.!!@# !.!%$%
23 !.!!++ !.!!+! ##.##+! !.!!!!#
"4 !.*$*! !.!%?* .$?? !.!!+%#
uhat* !.(!++ !.#(@% *.(*#@ !.!!%*%
uhat*_+ ,!.%#!# !.#!$@ ,?.*$%! !.!!!#@
uhat*_* ,!.(?+ !.#+#* ,@.@@@@ !.!!!%@
4,3-uared !.$%
<d.usted 4,s-uared !.$%
Page *#
'urbain,5atson +.!+
A,statistic %%.*$%?+
Prob:A,statistic; *.!(e,!(
The E>2 is run with the data at level form and at #
st
difference form.
H/)ot#!i!
7/J There is no relationship exists between "nflation) 2oney 3upply and "nterest 4ate in
Pakistan in long run at the significant level) K J !
Nersus
7#J There is relationship exists between "nflation) 2oney 3upply and "nterest 4ate in Pakistan
in long run at the significant level) K \ !
The above hypothesis will be tested by using A statistics and t, statistics.
E>2 is mostly used to determine the long run and short run relationship between the
variables. 9y applying it we obtain the following results.
"n these results) > J ,*.!(@%( shows constant coefficient. The value of K# is !.!!++ shows that
one unit increase in 2oney 3upply brings !.!!++ units change in dependent variable
"nflation and there is a positive relationship between the "nflation and 2oney 3upply in long
run and redirects the null hypothesis at !.!!!!# probability. 5hile the value of K
+
is !.*$*!
shows that one unit increase in "nterest 4ate brings !.*$*! units change in dependent
variable "nflation and there is a positive relationship between the "nflation and "nterest
4ate in long run and redirect the null hypothesis at !.!!+%# probability.
Page *+
4
+
measures the percentage of variation in the values of the dependent variable inflation
describe by the independent variables 2oney 3upply and "nterest 4ate in Pakistan at long
run.The value of 4
+
in my study is !.$% represents that the change in dependent variable
"nflation are $B explained by the independent variables "nterest 4ate and 2oney 3upply in
Pakistan.
The value of ad.usted 4
+
in my study is !.?$(@# shows that the change in dependent
variable "nflation is ?$B explained by the independent variables "nterest 4ate and 2oney
3upply in
Pakistan.
"f A,statistics value is greater than its probability then 7
8
will be re.ected and 7
# will be accepted.
"n my study A,statistics value %%.*$% is greater than its probability *.!(e,!(. 3o) it shows
that independent variables "nterest 4ate and 2oney 3upply both affect the dependent variable
"nflation. <t the end) the value of 'urbin 5atson test is +.!+ shows positive auto correlation.
<ll these result shows that our model is good fit.
Page **
>hapter !@
A"I'"I&3 4E>/22EI'<T"/I <I' >/I>0O3"I
FINDIN2S
"n this study some of the findings regarding inflation money supply and interest rate are as
follows.
#.
The data of 2oney 3upply) "nflation and "nterest 4ate has been proved non stationary at base
level it becomes stationary by taking #
st
and +
nd
difference.

+.
>orrelation suggests that there exists a strong positive relationship between "nflation) 2oney
3upply and "nterest 4ate.
*.
>o,integration test suggest that the "nflation) 2oney 3upply and "nterest 4ate are co,
integrated with each other.
.
E>2 shows that there exists a long run relationship between "nflation and 2oney 3upply.
@.
E>2 suggests that there exists a long run relationship between "nflation and "nterest 4ate.
Page *
RECO%%ENDATION
"nflation is a serious problem in both developed and developing economies. Pakistan is a
developing country and is facing this dilemma of consistent rise in inflation rate. "nflation
could not be controlled by taking a single measure. There are different determinants of
inflation which need to be monitored. <mong them money supply and interest rate should
be given keen attention to reduce the consistent rise in inflation.
#. The existence of the significant positive relationship "nflation and 2oney 3upply suggested
that the &overnment should adopt a tighten monetary policy to control 2oney 3upply to
decrease the "nflation
+. &overnment should impose strict monetary policies. The money supply should be
reduced to the market) so that there is e-uilibrium between demand and supply. Excess of
money in the market increases spending and unemployed resources increase output.
*. The existence of a long run relationship between 2oney 3upply and "nflation has great ef
fect on the economy) therefore the &overnment should adopt an ade-uate policy to control
the long run effect.
. The import prices should be reduced. 3o that necessary products could be easily available
in the market. &overnment should decrease tax duties on importsa
@. The problem of inflation can be resolved through b3trategic planning=. This process will
give a plan for future unfortunate situations. The unstable prices of oil in the international
market) the political instability and other such problems can be coped.
Page *@
(. Pakistan is an agricultural country) so agriculture sector should be supported by taking
subsidies. Aoreign investment should be invited to invest and take benefits from their
expertise.
?. "nflation has a direct relationship with interest rate. >entral bank uses the "nterest 4ate to
control 2oney 3upply. 7igh "nterest 4ate discourage the borrowing and low interest rate
encourage the lending resulting in increase in money) so the central bank of Pakistan
should sit the variation in the rate of interest to control the "nflation by controlling the
2oney 3upply.
CONC+USION
"n this study an attempt was made to understand the relationship between "nterest 4ate) 2oney
3upply and "nflation in Pakistan. "n this study "nflation is used as dependent variable and
2oney 3upply) "nterest 4ate are independent variables which are taken to investigate their
relationship with inflation. The period for investigating this effect is from #$$! to +!#!.
This study uses the co,integration analysis and Error >orrection 2odel to achieve the results of
the study. Error >orrection 2odel results suggest a long run relationship between binflation and
interest rate= and binflation and money supply=. The Cohansen co,integration statistics are
significant so the null hypothesis is re.ected with !.!@ significance level.
The correlation statistics shows that the independent variables have strong relationship with
inflation rate in Pakistan economy. The results show that there is significant relationship between
binflation and money supply= and binflation and interest rate=. <nd there is a long run relationship
between these variables. 3o whenever a policy is made to control inflation) these variables
should be given deep attention.
Sco) o0 0utur r!"rc#5
Page *(
"n this study there are some limitations. /ne of the important limitations is the use of only "nterest
4ate and 2oney 3upply with inflation but there are other variables which also effect the "nflation in
Pakistan like economic growth) import prices) higher duties and taxes) depreciating Pak rupees)
political instability) output set,backs etc. 4esearchers interested in the expansion of this study
should try to investigate the effect of other variables on inflation in the model. They should increase
the time frame of data. The researchers should use other model for the determinants of inflation.
This will help to understand the impact of inflation on the economy in Pakistan.
a
4EAE4EI>E3
Page *?
9runo) 2. and 5. Easterly :#$$(;. F"nflation and &rowth: "n 3earch of 3table 4elationshipH.
Aederal 4eserve 9ank of 3t. 0ouis 4eview) Nolume. ?%) Io. *. 9urstein) 2.0 :#$%(;. 2odern
2onetary Theory) The 2acmillan Press 0td. 7ong `ong.
>airncross) 3.< :#$?@; "nflation) &rowth and "nternational Ainance) &eorge <llen and Onwin
0td) &reat 9ritain.
>oghlan) 4. :#$%*; The Theory of 2oney and AinanceH. The 2acmillan Press 0td) 7ong
`ong.
Aischer) 3. :#$$*;. FThe 4ole of 2acro Economic Aactors in &rowthH. Cournal of 2onetary
Economcis) N/l. *+: %+,@#+.
&hosh) <. and 3. Phillips :#$$%;. "nflation) 'isinflation and &rowth. "2A 5orking paper Io.
5PY$%Y(%. 5ashington) '.>.: "2A.
7anan) 3. and &. 7ale :#$$!;. Economic "n Aocus. 7oarder and 3toughto 0td. &reat 9ritain.
7arberler) &. :#$?@;. The Phenomena of 5orld 5ide "nflation. <merican Enterprise "nstitute
for Public Policy 4esearch) 5ashington) '.>.
Chingan) 2.0. :+!!@;. 2onetary Theory. `onark Publishers Pvt. 0td.
0indauer) C. :#$(%;. 2acro Economics Cohn 5iley and 3ons 0td. >anada) O3<.
2eenai) 3.< :#$((; 2oney and 9anking in Pakistan. The <llies 9ook >orporation. `arachi)
Pakistan.
Page *%
Iasir) 2.3 :+!!;. 2acro Economic and Economic 'evelopment. "02" `itab `hana)
0ahore) Pakistan. asir) 2.3 and 3.` 7yder :+!!!;. Economics of Pakistan. "mtia1 Publishers)
0ahore) Pakistan.
3hahid) <.7. :+!!;. 2onetary Economics and Public Ainance. "02" `itab `hana) 2an1oor
Printing Press) 0ahore) Pakistan.
3hapiro) E. :#$$+;. 2acro Economic <nalysis &algotia Publications Pvt 0td. Iew 'elhi.
3hilling) <.& and `. 3okoloff :#$%*;. "s "nflation Ending6 <re cou 4eady6 2c &raw,7ill)
O3<.
3taats) 5.A. :#$%+;. 2oney and 9anking <merican 9ankers <ssociation) O3<.
Page *$