Impact of Inflation on Economic Growth in Sri Lanka

Abstract

It is broadly assumed that modest and stable inflation rate stimulates economic growth of a country. Modest inflation encourages savers, enhances investment and therefore speed ups economic growth of the country. The aim of this study is to examine the impact of inflation on economic growth in Sri Lanka for the period of 1988 – 2015 using the framework of Johansen cointegration test and Error Correction model. The results show that there is a long run negative and significant relationship between economic growth and inflation in Sri Lanka. These results support with the model of utility functions in consumption and real money balances, as exposed by Fischer (1979); De Gregorio (19930; Bruno & Easterly (1998) and disagree with the findings of Sidrauski‟s (1967) super neutrality of money in the long run. The results are more likely to support the utility functions in real money balances and consumption.

Keywords: Inflation, Economic Growth, Cointegration, Error Correction Model, Sri Lanka