The impact of public debt on inflation: a case study of Sri Lanka

Abstract

This study examines the impact of Public Debt on Inflation in Sri Lanka over the period of time1977 to 2015. The Augmented Dicky-Fuller (ADF), Phillips Perron (PP) and Ng- Perron unit root tests have used to test the order of integration. Akaike Information Criterion (AIC) is applied to determine the optimal lag length of each series. Error correction model (ECM) was employed to test the short-run relationship between variables as well as the long-run equilibrium of the variables. According to the findings of this study, the long run part of the results of ECM shows that public debt, real GDP per capita, trade openness and Government Revenue have significantly negative impact on inflation. Error correction coefficient of Inflation (-0.69) is negative and significant. It reveals that 69 percent disequilibrium is corrected each year which implies that Inflation moves downward towards long-run equilibrium. Therefore, special attention needs to be given by the government on reducing public debt in order to eradicate the inflation in Sri Lanka.