Impact of Capital Inflows on Domestic Inflation: A Case Study of Pakistan

Abstract

Inflation is a very important issue for an economy that’s why several empirical and theoretical studies have been done on it in different time period. This study is an attempt to find out the impact of capital inflows on domestic inflation. The variables used in this study are export, foreign direct investment, remittances, and inflation. By using the data from 1980-2010, we use unit root test to check the stationary. Cointegration Test and Error Correction Mechanism (ECM) are used to check the long run and short run relationship of FDI, REM, EXP and inflation. The results show that all the variables are stationary at 1st difference and there is positive relationship between FDI, REM, EXP and inflation. The results of cointegrating equation show that there is long run and significant relationship. So the policy implication for the high inflation is that we should use the capital inflows like remittances not only increase the consumption but also to increase the investment that causes economic growth.