Inflation and Economic Growth in Pakistan: Threshold Effects and Policy Implications

Abstract

The core aim of the study is to reconsider the existence and nature of the inflation economic growth relationship within the setting of the Pakistani economy by specifically deliberating the aspect of whether or not inflation affects economic growth positively or negatively through the income measured in GDP. The other issue examined in this research is whether the relationship works at the same level in various levels of inflation or whether it alters when a threshold is attained. Official national and international statistics were used to collect annual time series data that covered the time period between 1970 and 2019. Analysis of the data was done through Ordinary Least Squares (OLS) estimation process with descriptive statistical analysis being used to provide a profile of past trends. The empirical findings show a positive yet insignificant relationship between the inflation and growth in GDP in Pakistan indicating that low inflation might not be necessarily disastrous to the economy. Nevertheless, there exists a negative impact of inflation on GDP growth at a threshold level of about 7.5%. This implies that non-linear relationship exists. These results are consistent with the economic principles that moderate inflation may be used to boost production within an economy, yet continued high inflation reduces purchasing power, which deters investment and long term growth. On the basis of analysis, the study suggests that policymakers and the State Bank of Pakistan should keep the inflation rate lower and constant at the determined threshold level of 7.5 percent to improve the possible positive effect to the economic growth. This optimal range of price stability would be an effective macroeconomic tool to ensure that sustainable development is boosted in Pakistan.