Causality relationship of monetary policy on inflation in Sri Lanka

Abstract

Monetary policy plays an important role in stabilizing economic instabilities and especially, in controlling the rate of inflation in the Sri Lankan economy. The main objective of this study is to identify the causality relationship between monetary policy on inflation in Sri Lanka. In order to reach this objective Granger causality test is used to examine the causality relationship between the variables. The inflation, Gross Domestic Product, money supply, exchange rate, and trade balances are the variables used in this research. The analysis was carried out with secondary data for the period from 1980 to 2019 and the software of E-views 10 is used to analyze the data. The results of the stationary test show that all variables are non-stationary at levels but stationary at the first differences. The Granger causality test indicates that there is a bi-directional relationship between money supply and inflation, and economic growth, and trade balance have a uni directional relationship with inflation in Sri Lanka. On the basis of estimated results, the study concludes that the monetary policy has a causality relationship with inflation in Sri Lanka.