IMPACT OF INFLATION ON ECONOMIC GROWTH OF AFGHANISTAN
Muhammad Musa Parwani
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KARDAN UNIVERSITY KABUL
September 2 0 1 8
IMPACT OF INFLATION ON ECONOMIC GROWTH OF AFGHANISTAN
Muhammad Musa Parwani
Reg; 304 – 120 9021
Assistant Professor Kardan University Kabul
THE PROJECT REPORT IS SUBMITTED IN PARTIAL FULFILLMENT FOR THE AWARD OF DEGREE OF BACHELOR OF BUSNIESS ADMINISTRATION
KARDAN UNIVERSITY KABUL
PROJECT APPROVAL FORM
The undersigned certify that they have study the following project report and are satisfied with the overall performance and recommended the report to the faculty of Business administration for acceptance.
Mr. Usman Ali
Name of Supervisor
Signature of Supervisor
Mr. Aimal Mirza
Signature of Thesis Coordinator
Dr. Nassir Ul Haq Wani
Head of DRD
Signature Head DRD
I Mohammad Musa Parwani Registration # 340-120 9021 student of Bachelor of Business Administration (BBA) at the Kardan University Kabul, Afghanistan do hereby declare that the Project title as : “Impact of Inflation on Economic Growth of Afghanistan”
Submitted by me in partial fulfillment of BBA (Hons) degree, is my own work, and has not been submitted or published earlier. I declare that in Future it shall not, submitted by me for obtaining any other degree from this or any other university or institution.
Name: Mohammad Musa Parwani
First, I would like to thank almighty ALLAH who has guided me the way for a bright future. I would like to acknowledge the help provided by my teacher to make this project a success. My teacher Mr. Usman Ali khan provided guidance and learning at every step of the project, which help me a lot in the questioning , data collection and preparation of this report. He always gave full energy and shoed willingness in my project.
I am also thankful to my parents who accommodated me during those long hours of work in my project development and all my friends, colleagues who equally encouraged me.
Muhammad Musa Parwani
Dedicated to my parents who gave me life and raised me to the person I am today.
I owe them each moment of my life and praise them in every breath.
The Inflation changes over the time and they affect the Economic Growth in both the positive and negative manner. The paper tried to investigate the impact of inflation on Economic growth. Inflation is a key indicator of a country and provides important insight of the economy and sound macroeconomic policies. There is an agreement among many economist that a positive relationship usually exists between inflation and economic growth in the short run. A reasonable and stable inflation not only helps in economic growth but also improves the poor and fixed income section of the society unlike high price level that may create uncertainty and hamper economic growth.
It shows that there are studies in variables that determine the inflation rate in Afghanistan and those that affect other most important economic factors. It is a secondary source in collecting information.
Table of Contents
TOC o “1-3” h z “1. Ch Heading,1,1.1 Head,2,2.1 Head,2,3.1 Head,2,3.5.1,3,3.6.1,3,4.1,4,5.1,4” PROJECT APPROVAL FORM PAGEREF _Toc488572631 h IDECLARATION FORM PAGEREF _Toc488572632 h IIDIDICATION PAGEREF _Toc488572632 h III
ACKNOWLEDGMENT PAGEREF _Toc488572634 h IV
EXECUTIVE SUMMARY PAGEREF _Toc488572634 h V
1.1.Background of the study:1
1.2.Statement of the Problem:3
1.5.Significance of the Study:5
1.6.Scheme of the Study6
2.3.Empirical Review of Existing Studies:14
3.1.Research Design PAGEREF _Toc488572649 h 153.2.Research Type15
3.4.Data Type 16
3.6 Data Processing and Analysis16
3.7 Type of Study16
3.8Limitation of Study16 3.9Data Collection16
3.10Theoretical Framework3.10.1Independent Variable17
3.10.3HypothesisDATA ANALYSIS & RESULTS19 HYPERLINK l “_Toc488572660”
The Model (Regression Model)
4.1.2Testing normality of Variables PAGEREF _Toc488572662 h 194.1.3Analysis of the Model20
4.1.4Line of Estimations:21
Conclusions and Recommendations22
cHAPTER ONE INTRODUCTION
Background of the Study:
Inflation and economic growth are the main concern of most countries of the world. Thus, inflation and economic growth have gotten attention since the classical period. Macroeconomists, policy makers and central monetary authorities of all the nations need to know whether inflation is beneficial to growth or harmful to growth.
We can see the complexity of the relationship between inflation and economic growth from the result of studies conducted by different researchers. Studies that have been conducted about the relationship between inflation and economic growth found different results. Theories also have different views on issue of inflation and economic growth.
Inflation has been different in different dictionaries over the ages. Dictionaries have given different versions of definition regarding inflation. Inflation is an economic condition wherein the price of the goods and services increase steadily measured against standard level of purchasing power, whereas the supply of the goods and services decline along with the devaluation of money.
When the economy of a country faces inflation it brings bad news for the people because the supply of goods decreases and this scarcity causes a predicament for the people. The definition of inflation has undergone lot of changes since 1983 when it appeared in the dictionary for the first time. At that, time inflation was thought of as cause but as time passed by the definition and its significance changed. Economists from different schools differ in their opinion regarding the genesis of inflation. However, it is agreed that inflation occurs due to an unexpected risen the supply of money which causes devaluation or a decrease in the supply of goods and services. Again, the inflation rate decreases with the increase in the production of goods and with the decrease in the supply of money in the market.
The preview of inflation has narrowed in the present day since only the phenomenon of increase in the price level is termed as inflation these days. Previously, the devaluation of money was also considered a condition of inflation. In the present day, this phenomenon is known as a monetary inflation.
Inflation is a continuous rise in the price of goods and services. It is important to note that a rise in the price of just one or two items does not constitute inflation; nor does a one-time rise in all prices mark an inflationary period. To count as inflation, the price increases must be general throughout the economy and must continue over time. The hallmark of inflation is that money buys less than it once did. A cup of coffee that may have cost a dime at mid-twentieth century may cost a dollar some 50 years later.
The government can fight inflation by restricting demand for goods and services, usually by raising interest rates or imposing new taxes. Such measures tend to lead to higher unemployment, which dampens demands for goods and services and, in turn, brings down prices. Economists debate whether the cost of fighting inflation, e.g., higher unemployment and less growth, is worth the pain. Certainly many economists as not worth worrying about view a moderate amount of inflationary price increases, in the range of one to two percent per year. Inflation is measured by the government’s cost of living index. The opposite of inflation is deflation, a steady decline in the level of prices over time.
Means Gross domestic product, which represents the value of all those final goods and services that are created within a given economy. It represents the strength of an economy and is taken as a benchmark for following years for comparing. It also represent growth of an economy of a nation and such economies has better investment opportunities, higher wages, there is a high demand for labors and better employment opportunities. Therefore, it can be concluded that GDP represent the strength of the economy.
Nominal values of GDP (other income measures) from different periods can differ due tochanges in amount of goods and services and/or changes in the general price levels. As a result taking price levels (or inflation) into account is necessary if we are determining whether we arereally better or worse off when making comparisons between different periods. Values ofreal GDP are adjusted for differences in price level and the nominal GDP are not. The GDP deflator is an economic metric that converts output measured at current prices into constant dollar GDP and it shows how much change in the base year`s GDP relies upon changes in price level. GDP deflator is a preferred price index because it does not focus on a fixed basket of goods and services and automatically reflects changes in the consumption patterns and/or introduction of new goods and services. Therefore, this study used real GDP values at market price in the analysis.
In economics inflation is a sustained increase in the general price level of goods and services in an economy over a given period of time, when the general prices rise, each unit of currency buys fewer goods and services. Consequently, inflation reflects a reduction in the purchasing power per unit of money. Whenever there comes the discussion of the inflation people often get it negatively. However, control inflation is good in sense as well for economy. Inflation is always there whenever there lower interest rates and higher money supply. All these situations provide an opportunity for business activities. Because comparatively in case lower interest rates many people with surplus money wants to invest in businesses with higher returns instead of depositing their money in bank with lower interest rates. So somehow the inflation plays a vital role in the boosting the GDP and economy of a country.
Statement of the Problem:
The Afghanistan’s economy has remained underdeveloped for a long period despite being blessed richly with huge human and natural resources. This is a result of various factors such as corruption, unemployment, inflation etc. During the period under review, there has been an increase in the rate of inflation which has led to various economic bends, a situation whereby the government of a country interferes in the economy using policies such as fiscal and monetary policies, examples of some policies that led to distortions in the economy are minimum wage, lump sum tax, taxation, and government subsidies. The economy had a balance of payment deficit, in order to correct these various trade restrictions such as high import quotas, tariffs and export licenses were placed on the importation of various goods and services into the country. This led to a shortage in the availability of raw materials necessary for production thus leading to a decrease in the amount of goods and services available for purchase. This situation spurred inflation rate to a rise.
In an inflation situation, the value of money is reduced; that is, people have to pay more for buying a kilo of rice, or passengers must pay more for the purchase of a cable car in Mazar-e Sharif. However, the inflation rate and its maintenance at a certain rate varies from one country to another, depending on the economic situation of each country. Inflation is 3 to 5 percent public in the interest of each country, as it contributes to economic growth.
Control of the Inflation situation in Afghanistan more specifically, if I say, is the responsibility of the Central Bank (DAB) to address this situation and prevent deterioration. Da Afghanistan Bank, which was approved by the Karzai Transitional Administration as an independent legal entity on September 18, 2003, is responsible for applying contractionary and expansionary policies to maintain and maintain domestic prices, liquidity and ability to pay off debts. In addition, to ensure the stable functioning of the financial system in accordance with the system of the market economy. In Afghanistan, this can be seen as the era of the Taliban regime, and before that, the era of the government of Rabbani and Revolutionary Guards. For example, in order to buy a 50kg flour, we had to ship the Afghani money on another market. However, the general level of the price of goods and services has increased by 50% from one tower to the other, should be investigated. As a result, if it were positive, then at the time, Afghanistan would have been inflated or hyperinflationary.
From an economic standpoint, Afghanistan imported many more goods than they exported, leading to a trade deficit. The country has experienced a trade deficit every year over the past decade, most notably in 2011. Reasons for the ongoing deficit could potentially be the lack of government support for domestic production as well as stiff rules towards marketing. In addition, production and transport are likely to suffer due to the war. A trade deficit also implicates that a country borrows more money from other nations in order to sustain and fulfill the needs its economy, along with its citizens. The Asian Development Bank estimates the Afghan inflation rate to be constant and steady for 2015 and 2016. These rates are estimated with expectations of prudent and well-considered monetary and monetary policies, the rate of increase in agricultural production and the suitability of the price of foreign and imported goods. What economic realities in Afghanistan are and how it has been in the past year will be examined in another economic phenomenon, the economic downturn. A country where its trade balance is too high and its imports are multiplied by exports is likely to affect macroeconomic changes in the region and the world.
1.3 Research Objectives:
The objective of the research is to investigate the problem related to inflation rate and economic growth of Afghanistan.
This research tries to get the problem.
The objectives of this research are clear, which tries to find out the how intense is the impact of the inflation over the economic growth of Afghanistan and what steps can be carried out in order to decrease the negative impact of the inflation.
To examine how Inflation usually leads to higher nominal interest rates.
At the end of the study, it is clear, what is to be achieved by the researcher?
1.4 Research Question:
To meet the specific objectives stated above, this study was directed by the following research questions:
What is the trend of inflation with respect to the Economic Growth of Afghanistan?
What is the trend of inflation with respect to GDP of Afghanistan?
What is the relationship between inflation and economic growth of Afghanistan for the period of 2005 to 2016?
1.5Significance of the Study:
The significance of the study is that inflation is major problem in Afghanistan and affect people’s daily life like income, purchasing power, literacy rate, money supply, etc and they all effect economic growth of Afghanistan in some way and that further effect in country development. Therefore, it is important that we know how impact inflation has on economic growth and at what level of inflation we can positively manage our economic growth.
This study is very important to macroeconomists, financial analyst, academicians, policy makers and central bankers officials in understanding the responsiveness of GDP to the change in general price level and thus come up with the relevant policies to keep prices at the reasonable rate that stimulate production. It is necessary to policy makers to clear doubt as many studies on the relationship between inflation and economic growth remains inconclusive, several empirical studies confirm the existence of either a positive eight or negative relationship between these two macroeconomic variables. For example, Mubarak (2005) found that low and stable inflation promotes economic growth and vice versa.
The research findings will enable Afghanistan’s policy makers to come with policies regarding the growth of the whole economy.
1.6Scheme of the study
This thesis is consisting of five chapters and each chapter is further divided in to sub-headings. Following is the research scheme:
Introduces the study and states the focus of the study, begins with background information regarding the problem under investigation. The Introduction will provide readers with a brief summary of literature and research related to the problem being investigated, and will lead up to the statement of the problem.
Chapter two is to provide the reader with a comprehensive review of the literature related to the problem under investigation. The review of related literature will greatly expand upon the introduction and background information presented in Chapter 1. This chapter may contain theories and models relevant to the problem, a historical overview of the problem, current trends related to the problem, and significant research data published about the problem.
Chapter three presents a discussion of the specific steps used in the literature review and collection of data for the study. This chapter generally begins with a restatement of the research problem (and usually includes accompanying hypotheses or research questions) and indicates the major sections to be included in Chapter 3. The information regarding methodology will be comprehensive and detailed enough to permit replication of the study by other researchers.
Chapter Four provides results of data analyses and findings of the study, this chapter begins with an introduction (as do all chapters), which delineates the major sections to be included in the chapter, and may include a restatement of the research problem (and may include accompanying hypotheses or research questions).
Generally, this section summarizes the introduction, problem statement and hypotheses/research questions, literature review, methodology, findings and contains (will contain) a summary of the study and findings, conclusions drawn from the findings, a discussion, and recommendations for further study.
In this section, an extensive review of the previous scholars and academic work is done specifically on inflation and economic growth and this was guided by the specific objective of the study.
Various studies have been presented on the issue of inflation and growth. Most of this research work has been done internationally. We have critically reviewed some of thesis important empirical studies to develop objectives in the context of Afghanistan and, further, to analyze it to draw some important conclusions and policy recommendations.
Our discussion of the existing literature starts with an overview of most relevant theoretical studies, which investigate the determinants of economic growth. Then, we will discuss related empirical studies and their findings concerning the inflation-growth relationship.
This section contains different empirical studies that show the relationship between inflation and economic growth. The concern of previous studies was not only finding simple relationship between inflation and economic growth but also finding whether the relationship holds in the end or just a short run phenomenon, causal direction of the relationship, whether the relationship is linear or nonlinear and the like.
2.2. Theoretical studies:
Numerous theoretical studies investigated the association between inflation and growth. They can be divided into two groups. The first one contains inflation among dependent variables. For instance, the models by Clarida, Gali and Gertler (1999), Gali, and Gertler (2007) are given by a system of three blocks of equations, describing aggregate demand, aggregate supply and monetary policy. These models are based on real business cycle theory, extended with monopolistic competition and nominal price rigidities, and its main difference from the traditional Keynesian model, according to the authors, is that “all coefficients of the dynamic system describing the equilibrium … are explicitly derived from the underlying theory”. In this framework, inflation influences real output through real interest rate channel (Fisher equation) in the demand block and affects growth through expectation in prices in the supply part.
A different group of growth models does not explicitly include inflation in their framework. This group contains, among other models, the endogenous growth model for a small open economy developed by Minford and Meenagh (2006) and the endogenous growth model with public goods proposed by Barro (1998). These models are derived from an intertemporal utility function and perfect competitive firm sector with some production function. These frameworks differ from each other by some minor assumptions, having at the same time the common result.
Therefore, while the first group of models explicitly includes inflation as a factor of economic growth, the second group does not. However, the policy makers are particularly interested in first group of the models; hence, we will concentrate on it.
A common problem of many theoretical models is that the resulting systems of equations, which are obtained from the underlined assumptions, are highly dimensional and non-linear, which makes it hard to solve them in closed form without additional assumptions or some transformations. For instance, the basic equations for aggregate demand, aggregate supply and policy function form the three-dimensional system, which can be solved in general form only for few non-linear specifications. One of the most popular methods is linearization, which allows simplifying considerably the initial system and obtaining a solution in a feasible way. However, after this transformation all non-linear effects inside the model disappear.
At the same time, several theoretical studies argued that depending on its level, inflation could either promote or harm economic growth. For instance, Lucas (1973) explained that low inflation allows overcoming rigidity of nominal prices and wages. In addition, inflation can realign relative prices in response to structural changes in production during fast modernization periods. In this case, inflation is quite important for economic growth. On the other hand, high inflation creates “shoe leather costs”1 and “menu costs”2, discourages long-term investments and distorts a tax system (Romer, 2001).
In addition, let us consider different types of channels through which inflation influences economic growth. Several recent studies discussed interesting features of non-linearity in growth-inflation association. For instance, Huybens and Smith (1998, 1999) stated that even predictable inflation might harm economic growth by impeding financial sector allocating resources effectively.
Other theoretical studies focused on the question of how expected inflation affects the financial system. For example Choi et al. (1996) and Azariadas and Smith (1996) showed that only when inflation exceeds some critical level then it hampers economic growth, otherwise inflation has a favorable impact on growth. The authors explained this phenomenon using the so-called “adverse selection mechanism” in credit market. The brief idea is the following. There are two types of agents in the financial system: “natural borrowers” and “natural lenders”. The latter have enough funds to invest but do not have access to projects, while the former have many projects but insufficient funds to undertake them. The financial system plays important role in order to ensure channel from lenders to borrowers. If inflation increases then it reduces real rate of return on assets. In such circumstance, more people want to be borrowers rather than savers. At the same time new borrowers have higher default risk because they were not initially interested in getting credit, creating adverse selection problem for investors, which is called credit market rationing. However, investors will not be interested in providing loans for new borrowers, causing fewer loans in the financial market. As a result, a current increase in inflation rate leads to lower economic growth in the future.
The opposite situation takes place when inflation rate is reasonable low. In this case, credit market will operate in a Walrasian way3 and “adverse selection mechanism” will be absent. Then model will generate Mundell-Tobin Tobin effect 4 (Choi et al., 1996, Azariadas and Smith, 1996), which means that increase of inflation rate will cause substitution between resources that is agents will prefer to replace cash with human or physical capital. . Therefore, economic growth will be promoted (Choi et al., 1996). However, if inflation becomes higher than the threshold level, then credit rationing in the financial market appears harming growth.
2.3. Empirical Review of Existing studies:
Barro (1995) examines the issue and finds a significant negative relationship between inflation and economic growth, considering variables like fertility rate, education, etc. constant. The study contains a large sample data of more than 100 economies for the period 1960 to 1990 and to assess the effects of inflation on growth, a system of regression equations is used, in which many other determinants of growth are held constant. This framework is based on an expanded view of the neoclassical growth model as stated by Barro and Sala-i-Martin (1995). The study indicates that there exists a statistically significant negative relationship between inflation and economic growth. More specifically, an increase in the average annual inflation by 10 percentage points per year lowers the real GDP growth by 0.2 to 0.3 percentage points per year.
Bruno and Easterly (1995) address the issue of inflation and growth and find no evidence of any consistent relationship between these variables up to a certain level of inflation. They assess that the growth falls sharply during discrete high inflation crisis, above than 40 % percent, and recovers after inflation falls. Their empirical analysis shows that there exists a temporal negative relationship between these two variables beyond 40% percent threshold level. They conclude that there is no permanent damage to economic growth due to discrete high inflation crisis.
Sarel (1996) explores the possibility of non-linear effects of inflation on economic growth and finds a significant structural break, which occurs at annual average 8 percent inflation rate, in the function that relates economic growth to inflation. His results show that below that structural break, inflation has slightly positive effect on growth but after 8 percent inflation rate, it has powerful negative effect on growth. These results have been found by using OLS technique after constructing a joint panel database by collecting annual information of 87 countries for the period 1970-1990.
Using the annual time series data for the period 1971-1995, Khan and Qasim (1996) estimate the key determinants of inflation in Pakistan. They disaggregate inflation into food and non-food inflation and suggest a strong role of money supply in accelerating inflation in Pakistan. Other factors causing inflation, investigated by the researchers, are currency devaluation, value addition in agriculture sector, support price of wheat, import prices and price of electricity.
Short-run consequences of rapid disinflation are addressed by Ghosh and Phillips (1998), and find that starting from lower inflation rates; a rapid disinflation is associated with fall in GDP growth. They employ a large panel data set, covering IMF member countries for the period 1960–96. They find two important nonlinearities in the inflation- growth relationship. At very low inflation rates (around 2–3 percent a year, or lower), inflation and growth are positively correlated. Otherwise, inflation and growth are negatively correlated, but the relationship is convex, so that the decline in growth associated with an increase from 10 percent to 20 percent inflation is much larger than that associated with moving from 40 percent to 50 percent inflation.
Nell (2000) examines the issue whether inflation is always harmful to growth or not? Considering the South African Economy’s data for the period 1960-1999 and dividing it into four episodes, using Vector Auto Regressive (VAR) technique, his empirical results suggest that inflation within the single-digit zone may beneficial to growth, while inflation in the double digit zone appears to impose costs in terms of slower growth.
Faria and Carneiro (2001) investigate the relationship between inflation and output for the economy of Brazil where permanent inflationary shock has been observed for the last many years. They use a bivariate vector auto-regression composed of output growth and the change in inflation in order to test the hypothesis that inflation has long run impact on output. They also use the data for the same period 1980-95 to estimate the short run relationship between inflation and real output. Their findings verify Sidrauski’s superneutrality of money, which can be defined as inflation, has no real effect on output and productivity in the end. Their results suggest that inflation has real effects on output in the short run.
Using co-integration and error correction models, Malik and Chowdhury (2001) finds a long-run positive relationship between GDP growth rate and inflation for four South Asian countries. Supporting the Structuralists’ view, their results also suggest that moderate inflation is helpful to growth and faster economic growth feeds back into inflation. Thus, the authors recommend moderate inflation for growth of the economies of Bangladesh, India, Pakistan and Sri Lanka.
Khan and Senhadji (2001) examine threshold effects of inflation on growth separately for industrial and developing countries. The data set covers 140 countries from both groups and non-linear least squares (NLLS) and conditional least squares methods are used. The empirical results verify the existence of a threshold beyond which inflation exerts a negative effect on growth. Significant thresholds at 1-3 percent and 11-12 percent inflation levels for industrialized and developing countries have been found. The view of low inflation for sustainable growth is strongly supported by this study.
Gillman, Harris and Matyas (2002) present an econometric model with the feature of the inflation rate reducing the return to capital, by taking two samples of OECD and APEC member countries over the years 1961-1997. Inflation rate is included as central variable and the theory is related with the concept of equilibrium along the balanced growth path that is implicitly includes transitional approaches to the balanced growth rate. The results, consistent with Khan and Senhadji (2000), show that the effective is negative and significant at low inflation rates for the OECD .When inflation rate going from 0-10 percent range to a 0-5 percent range, the negative co-efficient nearly doubles in magnitude and remains highly significant.
Gokal and Hanif (2004) review several different economic theories to develop consensus on the inflation and growth relationship for the economy of Fiji. Their results show that a weak negative correlation exists between inflation and growth, while the change in output gap bears significant bearing. The causality between the two variables ran one-way from GDP growth to inflation.
Sweidan (2004) examines the relationship between inflation and economic growth for economy of Jordan and finds a structural break point at 2 percent level of inflation. Another issue, which is covered by the study, is to check the effect of inflation uncertainty on the growth and developments in the economy. The result implies that the effects of inflation on growth are stronger as compared to the effects of inflation uncertainty and variability.
Ahmed and Mortaza (2005) explore the relationship between real GDP and CPI and find threshold at 6 percent level of inflation for the economy of Bangladesh. The empirical evidence demonstrates that there exists a statistically significant long-run negative relationship between these two variables.
Mubarik (2005) estimates the threshold level of inflation in Pakistan using annual data for the period 1973 to 2000.The empirical results from his study suggest 9 percent threshold level of inflation for the economy of Pakistan, above which inflation is very unfavorable for economic growth. The study follows the work of Khan and Senhadji (2001) in which they calculate threshold level for both the developing, including Pakistan, and developed economies. They use panel data for 140 developing and developed economies for the period 1960 to 1998 and suggest threshold levels, 1-3 percent and 7-11 percent, for both group of countries respectively.
Hussain (2005) finds no definite threshold level of inflation for Pakistan and just suggests that 4-6 percent range of inflation is tolerable for economy of Pakistan. This study shows similar results with Singh (2003) which recommends 4-7 percent range of inflation for India. The researcher contradicts with Mubarik (2005) as 9 percent threshold level for Pakistan appears to be on the very high side. He also follows the methodology used by Khan and Senhadji (2001) and Singh (2003) and advises the central bank authorities to keep the inflation low and stable, irrespective of any threshold level.
Khan and Schimmelpfenning (2006) construct a simple inflation model, taking data of economy of Pakistan for the period January 1998 to June 2005 and find that monetary factors determine inflation in Pakistan. They examine long run relationship between the CPI and private sector credit and their results show that there may be no trade-off between inflation and growth in the short run but it certainly exists in the medium and long run. Their estimated results suggest 5 percent inflation target for sustained economic growth and macroeconomic stability for the economy.
Kemal (2006) finds that an increase in money supply over the long-run becomes the source of inflation and thus verifies the quantity theory of money .The results drawn by Khan and Schimmelpfenning (2006) have also been verified in the sense that the long- run excess money supply is the main responsible for inflation in Pakistan. This study contradicts with Hussain (2005) as its results imply that inflation in Pakistan is a monetary phenomenon.
Munir et al. (2009) analyze the nonlinear relationship between inflation level and economic growth rate for the period 1970-2005 in the economy of Malaysia. Using annual data and applying new endogenous threshold autoregressive (TAR) models proposed by Hansen (2000), they find an inflation threshold value existing for Malaysia and verify the view that the relationship between inflation rate and economic growth is nonlinear. The estimated threshold regression model suggests 3.89 percent as the structural break point of inflation above which inflation significantly hurts growth rate of real GDP. In addition, below the threshold level, there is statistical significant positive relationship between inflation rate and growth.
This chapter sets out different stages and stages that were followed in finishing the study. It included an outline for the gathering, estimation and Analysis of data. In this stage, most choices about how research was executed and how respondents were drawn closer and in addition when, where and how the examination or research was finished. Consequently, in this area the research recognized the systems and methods that were utilized as a part of the gathering, preparing and investigation of information or data. In particular, the accompanying subsections were incorporated; research design, data accumulation instruments, data gathering techniques lastly data analysis.
3.1 Research design
Research design is a plan that specifies how data from the study was collected and analyzed. For this study Quantitative, research is used particularly based on the measurement of quantity or amount. It is applicable to phenomena that can be expressed in terms of quantity.
Researcher used Quantitative research because it tests and validates already constructed theories about how and why phenomena occur, it tests hypotheses that are constructed before the data are collected and it can generalize research findings when the data are based on random samples of sufficient size. It also provides precise, quantitative, numerical data, Data analysis is relatively less time consuming (using statistical EViews software) and it have higher credibility and is useful for studying large numbers of population.
3.2 Research TypeThis is Exploratory, cause and effect research design because it does not intend to give the last and final responses to the research questions but it explores the research topic with varying levels of depth and it’s the underlying and initial research which forms the basis for more conclusive research. A cause-effect relationship is a relationship in which one occasion (the cause that is macroeconomic variables) makes another occasion happen (the impact, which is Forex). One cause can have a several impacts.
3.3 Population ProceduresThis is a total population sampling procedure, which the researcher chooses to examine the entire population (Afghanistan).
3.4 Data type and Source
The study used Time series data and the data was collected from the Statistics website and Da Afghanistan Bank website.
3.5 Methods/ Techniques
A main measure of price changes is inflation rate. The quarterly percentage change in the general price index (normally the consumer price index) over time.
3.6 Data processing and Analysis.
The research first carried out a descriptive study on the variables and tested for whether they were trended or instable. He further carried out a normality test and concluded using probability, this aimed to see whether the variables were normally distributed.
3.7Type of Study
This study has tried to find out the relationship b/w IVs (independent variables –Inflation Rate) and DV (dependent variable –Economic Growth of Afghanistan).
3.8 Limitation of the Study:
This study focuses on the effects of inflation targeting on economic growth in Afghanistan. This means that it is limited to an Afghanistan context; and therefore, is not applicable to any other region outside Afghanistan.
This Study is only on Afghanistan and Limited to the Year 2005 to 2016.
This study in only tries to see impact of Inflation on Economic Growth in Afghanistan.
Limited time, as it was an educational purpose thesis.
In this research, secondary data from year (2007-2015) was collected from sources such as Da Afghanistan Bank (DAB), Afghanistan Central Statistics Organization, Ministry of Commerce and Industries, World Trade Organization, World Bank.
Most of the data was collected through Secondary Sources like;
Official web site of World Bank & DAB (Da Afghanistan Bank)
UNDP annual economic survey report
WEO World Economic Outlook
IMF annual economic survey report
3.10 Theoretical FrameworkThis research has considered Inflation Rate as independent variables and Economic Growth as dependent variable.
3.10.1 Independent variableInflation rate
3.10.2. Dependent variableEconomic growth of Afghanistan
3.10.3 HypothesisH1.The inflation rates and economic growth has relationship with each other. The ModelThe model consisted inflation rate as independent variables and economic growth as dependent variable as mentioned above in theoretical framework. There are also some other macroeconomic variables which can be included in independent variable but since it is an academic thesis and time is short so that’s why those are skipped for the time being. However, if they were considered, there would be no change with the methodology.
The model can be explained as the variation and ups and down in dependent variable (economic growth) is because of mentioned independent variables (inflation rate).
Model is somewhat like this:
?Y=a+b (? Inf. Rate)Where
?Y= ? in Economic Growht of Afghanistan? Inf. Rate=Change in Inflation rateb (beta)=Slope of the independent variablesa alfa=Y interceptFor the implementation of the model, an (12) years’ secondary data was taken into consideration (2005-2016) and on yearly basis.
DATA ANALYSIS & Results
This chapter presents examination, Analysis and discoveries of the study as set out in the research objective and research methodology. The study findings are exhibited on the variables that decide trade rates in Afghanistan and how those elements affects the trade rates. This chapter is meant for analyzing the model with the help of data gathered from secondary sources. In addition, the analysis passes through the following stages;
4.1.2 Testing normality of VariablesFirst of all the normality of data was checked to with the help of Kolmogorov-Smirnov test whether is normal or not.
Table 4.1.2: Normality test
Statistic df Sig. Statistic df Sig.
Inflation Rate .152 12 .200* .959 12 .769
GDP .159 12 .200* .928 12 .360
a. Lilliefors Significance Correction *. This is a lower bound of the true significance. The normality of the data can be confirmed through the sig column of Kolmogorov-Smirnova test.
By looking at the significance column, the significance values of variables are greater than 0.05, which means that the data is normal.
4.1.3.Analysis of the ModelThe first table of interest is the Model Summary table, as shown below:
Model R R Square Adjusted R Square Std. Error of the Estimate
1 .783a .672 .774 1355.79133
a. Predictors: (Constant), Inflation Rate From this table we will consider R and R square values. R-value represents simple correlation and is 0.783 (the “R” column), which indicates high degree of correlation. The R square value (the “R Square” column) indicates how much of the total variation in dependent variable (Economic Growth) can be explained by Independent Variable (Inflation Rate). In this case, 67.2% can be explained, which is high enough.
The next table is the ANOVA table, which reports how well the regression equation fits the data (i.e., predicts the dependent variable) and is shown below:
Model Sum of Squares df Mean Square F Sig.
Regression 3459987.886 1 3459987.886 1.882 .003a
Residual 1.838E7 10 1838170.129 Total 2.184E7 11 Predictors: (Constant), Inflation Rate
b. Dependent Variable: GDP This table indicates that the regression model predicts the dependent variable significantly well. How do we know this? By look at the “Regression” row and going to the “Sig.” column. This indicates the statistical significance of the regression model that was run. Here, p < 0.0005, which is less than 0.05, and indicates that, overall, the regression model statistically significantly predicts the outcome variable (i.e., it is a good fit for the data).
The Coefficients table provides us with the necessary information to predict economic growth from inflation rate.
Model Unstandardized Coefficients Standardized Coefficients t Sig.
B Std. Error Beta 1 (Constant) 8057.258 550.054 14.648 .000
Inflation Rate -.455 .093 -.598 -6.372 .030
a. Dependent Variable: GDP Coefficients table determine whether inflation rate contributes statistically significantly to the model (by looking at the “Sig.” column). The beta value -0.455 and the sig. value .030 of inflation rates states that inflation rate has significant negative relationship with economic growth of Afghanistan, as sig. value is < 0.05.
Furthermore, we can use the values in the “B” column under the “Unstandardized Coefficients” column, as shown below in Line of Estimation:
4.1.4.Line of Estimations:
The Estimation Line of Economic Growth of Afghanistan will look somewhat like:
?Y= a+b?xEconomic Growth= 8057 -0.455 (Inflation Rate)chapter fIVE
CONCLUSIONS AND RECOMMENDATIONS
Investors are likely to hear the terms inflation and gross domestic product (GDP) just about every day. They are often made to feel that these metrics must be studied as a surgeon would study a patient’s chart before operating. Individual investors need to find a level of understanding that assists their decision-making without inundating them in piles of data. Find out what inflation and GDP mean for the market, the economy and your portfolio.
This study is about the relationship between inflation and economic growth in Afghanistan. The significance of the study is that inflation is major problem in Afghanistan and affect people’s daily life like income, purchasing power, literacy rate, money supply, etc. and they all cause different effect on economic growth of Afghanistan in some way and that further effect in country development. So it is important that we know how much of an impact inflation has on economic growth.
In this chapter, conclusion of the findings, policy implication of the findings as well as the recommendations for further studies has been given.
5.2ConclusionThis study is just an academic research and there are other independent variables as well, which are directly or indirectly affecting economic growth of Afghanistan, but due to time limitation, this research is limited to only one independent variable –inflation rate.
12 years data was collected (2005-2016) on yearly basis. Significance value (0.003) in anova table and R square value (0. 672) in model summary table shows that this model is a good fit, but 67% of the variation in economic growth is because of inflation rate. There is other independent variable (political instability, interest rate, gold prices, exchange rate etc.) as well which are affecting economic growth but those were ignored in this research due to time limitation.
The beta value (-0.455) with sig value (0.030) shows that there is significant relationship b/w inflation rates and economic growth of Afghanistan as the P-value 0.030 > 0.05.
In reality, low inflation rate and an upward economic growth is never possible. Nevertheless, low inflation rate means slow economic growth. Whenever, money is in excess, there is bidding by the consumers due to which the cost of goods escalate.
Based on the results, findings and conclusions the following recommendations have been deciphered.
On the foundation of this research, it can be suggested to maintain the inflation rate underneath the point of 8 percent in the economy. Thus, the strategy makers and the DAB (Da Afghanistan Bank) should give attention to on those options, which keep the inflation rate steady and underneath the point, which has been found the useful for accomplishment of steady economic growth.
Modest and constant inflation is also useful for diminishing the fluctuations and doubts in the financial sector of economy, which, in turn, increase the assets development behavior in the country. Thus, that it may possibly put forth its encouraging effects on the economy. Therefore, sustained price constancy will eventually be the finest strategy suggestion to steady and constant economic growth of the economy.
As we try to exploit the long run impact of inflation on economic growth, our findings from this study shows that inflation has a long run negative and permanent effects on real GDP.
The test further shows that there is strong interconnection from real GDP to unemployment. While the policy makers are watchful of the movements in general price level, policies that tend to reduce inflation can be costly to the society as it is likely to slow economic activities and cause a rise in unemployment rate in the short run. The rise in unemployment rate that results from inflation reducing policies could have a temporary multiplier effect through the social hardship that would be inflicted upon those negatively affected by such policies.
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