Co-Integration Analysis of the Determinants of Inflation in India

Inflation refers to a general rise in prices measured against a standard level of purchasing power. The most well-known measures of Inflation are the CPI, which measures consumer prices, and the GDP deflator, which measures inflation in the whole domestic economy. In India, the average inflation rate from 1969 to 2010 is measured at 7.99 percent with historical high of 34.68 percent (September 1974) and a record low of -11.31 percent (May 1976). Economists generally agree that high rates of inflation are caused by an excessive growth of money supply, but there are many factors (real or monetary) which have an Iinfluence on inflation Indices. This paper seeks to shed some light on the determinants of inflation in India during April 2001-March 2011, and to estimate a more specific relationship between inflation and its determinants using Johansen Co-Integration and Vector Error Correction Model (VECM). The Johansen Co-Integration test applied on selected data Indicated four long run equilibrium relationships for inflation with its determinants. The results of VECM Indicated a positive relationship between GDP and the CPI, and a high degree of Interdependence between money supply, crude oil prices and inflation in India.