The Main Determinants of Inflation in Sri Lanka: A VAR based Analysis
Mr. H.P.G.S. Ratnasiri is a Deputy Director in the Financial System Stability Department of the Central Bank of Sri Lanka. He received his B.A. (Hons) Degree in Economics from the University of Peradeniya and M.A. Degree in Economics from the University of Peradeniya and M.A. Degree in Economics from Vanderbilt University, USA. His research interests are in Development Economics, Agricultural Development, International Economics and Financial Stability.
This paper attempts to examine the main determinants of inflation in Sri Lanka over the period 1980 – 2005 using Vector Autoregressive analysis. The results presented in this paper indicate that money supply growth and rice price increases are the main determinants of inflation in Sri Lanka in the long run. In contrast, It is evident that exchange rate depreciation and out put gap have no statistically significant effect on inflation. In the short run, rice price is the most important variable as it is a totally endogenous variable. However, money growth and exchange rate are not so important variables as they are weakly exogenous in the adjustment process. Output gap does not have a statistically significant effect on inflation in both the long run and the short run.