The topic of this research is relationship between inflation rate and GDP growth of Pakistan. Nowadays in Pakistan inflation rate is high, when inflation crosses logical limits, it has negative effects on GDP growth. It drops the value of money, resulting in uncertainty of the value of profit & loss of borrowers, lenders, buyers and sellers. The rising the uncertainty in saving and investment. In Feb 2009 CPI Inflation rate of Pakistan was 22.97% and GDP was 5.8%. GDP and inflation rate negative correlation present even when other factors are included to the study and the investment rate, population of growth, and the constant advances in technology and still when the factor in the effects of supply shocks features of a part of the observed period
In this research determine how much rate of inflation affect the GDP growth of Pakistan. In this research also determine inflation rate significantly affect the GDP growth of Pakistan. GDP shows the economic performance of a country so it is of most importance for concerned departments and economists of that country. On the other hand rising inflation can impact negatively on GDP and the objectives that a country achieves can be demolished by rising inflation.
If GDP growing fast and rate of inflation is falling down, it is good for the economy. More money comes in Pakistan and financer invests more and more capital. GDP indicates all sectors such as agriculture, telecommunication, services, manufacturing and Per Capita Income. These all indicators represent the country's economy. If these sectors were growing fast, country's economy also grows faster.
Foreign investors observe the market condition of Pakistan and foreign investors must see the GDP & Inflation Rate of Pakistan. If the GDP growing faster and inflation going down, foreign investors invest more money into Pakistan. If GDP is growing faster, the investor earns more money and achieves good profit and aspires to keep doing business for long term and expects less risk for the loss. Investors also expect for greater dividend in real terms, if rate of inflation is dropping down.
This research is also significant for foreign investor and domestic investor of stock market. If inflation is increasing, investors invest less in market because investors do not expect good profit and dividend for the shares and also expect huge risk in market for long term. If any country's inflation rate is increasing, it is very difficult for financial institution to maintain the trust of investors because there is a chance of loss for the investors.
This research is also significant for exporters. Exporters must see the inflation and GDP of Pakistan. If inflation is increasing, exporters export fewer goods because goods are expensive for exporters due to high inflation. Exporters export more goods, when inflation is low because goods are affordable for exporters and easy to export goods.
This research is also significant for fresh graduate students. If inflation is high, there is less chance of jobs because the rate of unemployment is also high due to inflation rate. Fresh graduate also do not start business because it is carries more risk and there is chance waste of capital.
H1: There is a negatively relationship between the Inflation rate and economic growth of Pakistan.
H2: Inflation rate significantly effect on economic growth rate of Pakistan.
1.5 SUMMARY OF RESEARCH:
The overall summary of this research defined in the following parts:
First chapter is Introduction. In this part describe overview of all research, research problem, hypotheses of this research and definitions used in this research.
Literature Review is second chapter. Describe summary of all articles, which related to this research.
Third Chapter is Research Method. In this part describe data collection method, how sample size of this research and also describe technique of this research.
Fourth Chapter is Results. In this part includes interpretations and findings in relevance to the hypotheses test. In this part also describe hypotheses assessment summary in table form.
Fifth and last Chapter is Conclusion. In this part includes discussion based on this research finding in setting with the past research findings. In this part also describe some recommendations and implications of this research and also describe future research possibilities. Ending this part with conclusion.
GDP and Inflation are the key macroeconomic indicators of the economic performance of any country. The relationship and cause & affects are very important for any economic performance of the country.
GDP Economic Growth:
GDP indicates only currently produced goods and services. It is a flow measure of output per time period. For Example, per quarter or per year and indicates only goods and services produced during this interval. Such market transactions as exchange of previously produced houses, cars or factories do not enter into GDP. However, two types of goods used in the production process are counted in GDP. The first is Capital Goods and other type of goods is Intermediate Goods (Froyen, 2005).
Components of GDP:
GDP is broken down into the components. The first component is Consumption component of GDP. Consumption consists of the household sectors. Consumption can be further broken down into consumer durable goods (e.g. automobiles, television), nondurable consumption goods (e.g. foods, beverage, and clothing) and consumer services (e.g. medical services, haircuts) (Froyen, 2005).
The second component of GDP is Investment. Investment is part of GNP (Gross National Product) purchased by the business sector in addition residential construction. Investment divided into three sub components. First is business fixed investment, second is residential construction investment and final id inventory investment (Froyen, 2005).
The third component of GDP is government purchases. It is goods and services that are the parts of recent output that goes to the government sector such as federal government, state and local government (Froyen, 2005).
The final component of GDP is Net exports. Net Exports equal total (gross) export minus imports. Gross exports are currently produced services & goods and sold to foreign buyers, should be counted in GDP. Imports are purchases by domestic buyers of goods and services produced abroad and should not be counted in GDP. Imported goods and services are, however, included in the consumption, investment and government spending totals in GDP. Therefore, need to subtract the value of imports to arrive at the total of domestically produced goods and services (Froyen, 2005).
Inflation is when prices continue to keep rising, typically as a result of overheated economic growth or extra capital in the market search for too few opportunities. Wages usually creep upwards, so that companies can retain good workers (Amadeo, 2008).
How Protection Inflation:
If person are locking inflation protect alone, one best way to protect. Person purchase treasury bills and bonds; there pay fixed rates of interest. However, twice a year the governments readjust the principle in response to changes in the CPI, published monthly by the Statistics Bureau. It's mean, as inflation increases, the value of bonds increases. This is best way for protect inflation, when inflation increases (Amadeo, 2008).
Aggregate Demand Theory:
Aggregate Demand Theory shows that the negatively relationship between Inflation rate (price Level) and output/income (National Product). Aggregate Demand theory was developed by the English economist John Maynard Keyness (1883-1946). Term of 'Aggregate' was also used as 'aggregate spending' and 'aggregate expenditure' (Case and Fair, 1992).
An extensive literature had examined the relationship between the budget deficit/Income growth and inflation. At a theoretical level, Sargent and Wallace (1981) showed that under certain conditions, if the times paths of government spending and taxes were exogenous, bond-financed deficits were non-sustainable, and the central bank should eventually monetize the deficit. Money supply and inflation was rising in the long run. These findings had subsequently been generalized for the open economy case and for alternative forms of financing. Increase money supply and inflation in the long run due to the government spending and economical condition were not sustainable (Scarth, 1987; Langdana, 1990).
Metin (1995) analyzed inflation for Turkey using a general framework of sector relationships and found that fiscal expansion was a determining factor for inflation. The excess demand for money affected inflation positively, but only in the short run. On the other hand, imported inflation, the excess demand for goods, and the excess demand for assets in the capital markets had little or no effect on inflation. A key policy implication of was that Turkish inflation could be reduced rapidly by eliminating the budget deficit. The demand for money, assets and goods impact on inflation (Metin, 1995).
The losses were automatically financed by the credits extended by the Central Bank to the SEE's, resulting in high money growth. For 1950 period in Turkish inflation rising and balance of Payment had difficulties. Most the private firm purchase commodities at official price and reached experienced losses (Aktan, 1964; Okyar, 1965; Fry, 1972; Krueger, 1974, Onis and Riedel, 1993).
Metin (1958) implemented a fairly typical International Monetary Fund (IMF)-supported stabilization program, which improved the foreign-exchange situation and drastically reduced inflation. The most important component of the program was an increase in the prices of SEE goods, a component that was featured prominently in the 1970 and 1980 reforms as well. Raising those prices in 1958 resulted in an immediate and once-and-for-all increase in the price level, after which the reduced rate of expansion of Central Bank credits reduced inflation. Metin (1958) analyzed inflation dropped from 25% in 1958 to less than 5% in 1959, real gross domestic product (which had been declining) started growing immediately due to the greater availability of imports. In 1958, Turkey improved foreign exchange situation and reduced inflation. Increase the price of those which reduced rate of expansion of central bank credits reduced inflation by 5% in a year and due to this reduced inflation, GDP started growing immediately.
Metin (1998) analyzed that Turkey was among the more rapidly growing developing countries during most of the 1960s, with an annual inflation rate of 5%-10%. The nominal exchange rate was kept constant after the 1958 devaluation. Investment spending increased and was financed mainly by foreign aid. In the late 1960s, foreign id did not increase, but the rate of investment spending was maintained. In addition, some difficulties appeared in obtaining imports, creating visible restraints on economic activity and growth. Turkey's Economic volatility in deferent sectors such as in the late 1960s, foreign aid did
not increase, but the rate of investment spending was maintained. In addition, some difficulties appeared in obtaining imports, creating visible restraints on economic activity and growth
Barro (1995) studied that If a number of countries characteristics were held constant, in that case regression results shows that an raise in average inflation of ten proportion points per year reduces the growth rate of real per capita income GDP by 0.2 to 0.3 proportion points per year and lowers the proportion of investment to GDP by 0.4 to 0.6 proportion points. Over here come to know that some characteristics were stay constant but some of effected due to increase of inflation rate result reduce the growth rate of real per capita.
Barro (1995) analyzed the result that inflation control on growth looks little; the long term inflation effects on standards of living were considerable. such as, a shift in monetary policy that increase the long-term average of inflation rate increase by ten percentage points per year was projected to down the level of real GDP after 30 years by 4% to 7%, more than enough to justify a strong interest in price constancy. The inflation rate's influence intensively effected lives standard which identifies by the Monitory Policy, average inflation rate and GDP.
To evaluate the effects of inflation on economic growth, Barro (1995) Regression Equation method used to which many other determinants of growth were held constant. The framework was one that in this paper had developed and applied previously. Barro (1995) identified that tool through in this paper assessed influence of inflation on the development of economy and to evaluate the effects of inflation on economic growth.
Fama (1981) explained these anomalous stock return-inflation relations. The data were consistent with the hypothesis that the negative relations between stock returns and inflation positive relations between stock returns and real variables which were more fundamental determinants of equity values. The inflation had negative influence on stock return and also real variable
Metin (1995) examined the relationship between the public- sector deficit and inflation. System co-integration analysis suggests three stationary relationships. Although weak relation does not hold for variables concerned (except Ay), one was still able to develop a conditional model for inflation. In that model, an increase in the scaled budget deficit immediately increases inflation. Real income growth had a negative immediate effect and positive second-lag effect on inflation. The shortfall affected inflation at a second lag. These dynamics were consistent with institutional and general knowledge of the economy. The conditional model of inflation was constant over the sample period, even though several significant structural breaks occurred during the period. Breaks included three devaluations, structural stabilization, and economic liberalization programs. The major finding from the new equation was that budget deficits (as well as real income growth) significantly affect inflation in Turkey.
Braun and Tella (2000) studied that there was a positive partial correlation between inflation and corruption for several countries for which data was available. Furthermore, argue that causality was from inflation variability to corruption. There was a positive relationship between inflation and corruption.
Dornbusch and Frenkel (1973) had developed alternative approaches to be analysis of growth and inflation. found that the effect of inflation on per capita real balance, consumption and the capital-labor ratio remain ambiguous if the yield on capital was a function of per capita real balance or if consumption was an increasing function of the rate of inflation. That ambiguity was in general not entirely removed by consideration of maximization and a specification of the nature of the service of real balance. The alternative effects inflation on per capital real balance, consumption and the capital labor ratio.
Fama (1981) tested out the hypothesis that the negative relations between real stock returns and inflation observed during the post-1953 period were the consequence of proxy effects. Stock returns were determined by forecasts of more relevant real variables, and negative stock return-inflation relations were induced by negative relations between inflation and real activity. This relation inflation, real activity and stock returns define through the money demand and the quantity theory of money.
Barro (1995) evaluated the effect on investment shows up clearly only for inflation rates above 10%-20% per year. For lower inflation rates, the estimated effect of inflation on the investment ratio tends not pointedly different from zero. The investment effects positively when inflation above 10% to 20% per year but lower inflation effect on investment negatively and zero inflation not significantly effect on investment.
Barro (1995) analyzed that the Inflation effects on growth and investment were significantly negative and long term Inflation to reduce the value of growth and investment. The analysis was that the effects of inflation on growth were significantly negative relation and also the effects of inflation on investment were significantly negative relation.
Barro (1995) the values of inflation for three periods (i.e. 1965-75, 1975-85 and 1985-90) were not differing significantly from one to another. If different coefficient of inflation test for each period, then resulting values was not significantly from one to another period. If the inflation rise 10% year, growth rate of real per Capita income of GDP by 0.2% to 0.3% point per year.
Khan and Senhadji (2001) located that under floating exchange rates, growing domestic inflation can move up long-run output if credit was rationed (inflation was low). However, there exist inflation thresholds as were observed empirically inflation and output were positively (negatively) correlated below (above) the threshold. With fixed exchange rates, the scope for credit to be rationed depends in a relatively complicated way on the rate of foreign and domestic inflation, and increasing foreign inflation always reduces long-run output.
Barro (1995) calculated the standard deviation and analyzed the result was that if the standard deviation of inflation was included in the regressions, then the estimated coefficient on average inflation changes little, and the estimated effect of the standard deviation of inflation was still around zero. Standard deviation of inflation included in the regression, result of estimated coefficient on average inflation was little and standard deviation was around zero.
Results were directly related to the literature on the costs of inflation. Despite a long tradition of research on the subject, empirical estimates were scant. Following Bailey (1956) estimating the area under the money demand curve, Fischer and Lucas (1981) found that for the US, an inflation rate of 10-percent per annum would cost 0.3-
0.9 percent of national income each year. More recently, Fischer (1993) estimated in a cross-section of countries that an increase in the inflation rate of 100 percentage points would lead to a reduction in the annual growth rate of 3.9 percentage points.
Barro (1997) found that the negative relation between inflation and growth was stronger for low levels of inflation, and that inflation variance was also negatively correlated with growth. The estimated in a cross section of countries that an increase in the average inflation rate of 10 percentage points per year leads to a reduction in the growth rate of GDP of 0.3 to 0.4 percentage points per year.
Braun and Tella (2000) presented the cross section estimates of the correlation between inflation variability and corruption. Average the data for 1982-1994 to obtain a maximum sample. Document a positive and significant correlation between measure of noise in the price system (Inflation Variance) and corruption. The Positive and significant correlation between the inflation and corruption
Barro (1995) analyzed that it was also possible that the inflation produce a positive and significant relationship between inflation and growth. This thing happen, when demand of goods increase.
Braun and Tella (2000) analyzed the result was that the increase in the cost of audit leads to an increase in corruption and in the extant fixed cost of investing. This in turn leads to a decline in aggregate investment and growth. Using the evidence that relative price oscillations increase with inflation variability, assume that the cost of audit was an increasing function of inflation variability. If corruption was increasing, Growth and Investment was decrease because negatively impact on growth and investment. Inflation was increasing due to corruption was rising.
This research finds out the relationship between the Inflation and GDP growth of Pakistan with the help of model. In this research result shows that the there is no negatively relationship between the inflation and GDP growth in Pakistan. Result also shows that inflation is insignificantly affected on GDP growth of Pakistan.
The past researchers also showed that there was not relationship between inflation & GDP and also showed that there was not negatively relationship between GDP and inflation rate. First researcher result was yearly data presented a positive and insignificant association between corruption and Inflation rate for 75 countries data and also increase in inflation rate can lead to increase in corruption and decline in growth rate and this result also showed that the negative and insignificant association between inflation rate and growth rate in yearly data for 75 countries data over.15 years (Branu and Tella, 2000). Second researcher result was significant relationship between industrial production growth rate and inflation rate was found only for five countries out of eighteen OECD countries, this result showed that another 13 OECD countries was found insignificant relationship between the inflation rate and growth rate of industrial production (Katsimbris, 1985). Third researcher result was the significant negative relation between inflation and growth only for high inflation rates; the relation was insignificant if the sample was limited to rates below 10% per year (Barro, 1995). In this research only 2009 CPI shows 20.78% but another 21 years data almost showed 10% per year.
Result might not be accurate in this research because these are the following limitation. In this research did not cover all sectors of GDP growth rate individually. In this research also did not cover GDP and the sectors' amounts individually in US Dollars or Pak Rupees. In this research did not cover individual test on SPI, CPI and WPI or average of these entire three inflation measuring rates. In this research only included 22 year observation. If these limitations cover this research, result might be more accurate.
These research results will significance for foreign investors and domestic investors. Foreign investors and domestic investors will observe the market condition of Pakistan with the help of this research. This research will conduct more properly in future research with the help of this research finding.