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Abstract

It is of significant economic importance to investigate the relationship of the inflation-growth nexus in Sri Lanka, to identify whether there is a linear or non-linear relationship between the two macro variables. This can lead to the discovery of the threshold level of inflation for Sri Lanka. Accordingly, this research explores the inflation-growth relationship in Sri Lanka, using annual data from 1965 to 2014. The results reveal an inflation rate of 9 per cent, which maximises the per capita GDP growth rate in Sri Lanka. However, the results do not confirm any significant structural break in per capita GDP growth rate when the inflation rate exceeds 9 per cent. Therefore, based on the findings, there is no statistically significant evidence to suggest the existence of a non-linear relationship between per capita GDP growth and inflation in Sri Lanka. Some conjectures, such as errors in data and not including savings and investment data can be made regarding the non-existence of a significant inflation threshold. Furthermore, the findings highlight that there is no negative effect of inflation towards the GDP per capita growth at any rate of inflation in Sri Lanka. This is an indication that any adverse effects of contemporaneous inflation are neutralized due to the significant positive effects from the inflation lag of two years. Furthermore, the results are not in favour of the view of maintaining inflation at low levels and thus, this study is important for policymakers in Sri Lanka, when implementing inflation targeting in Sri Lanka in the future.

Keywords: Per-capita income growth, Inflation threshold, Structural break, Sri Lanka

How to Cite: De Silva, B.G.N., 2017. Inflation - Growth Nexus in Sri Lanka: is there a Threshold Level Of Inflation for Sri Lanka?. Staff Studies, 47(2), pp.1–26. DOI: http://doi.org/10.4038/ss.v47i2.4704