An Analysis of Relationship between Remittances and Inflation in Pakistan

Abstract

Remittances play a significant role in the economic development of recipient economy through different micro and macroeconomic channels. However, the adverse impact of remittances in the form of Dutch disease and inflation cannot be overlooked. This study aims to examine the impact of remittance on inflation and its different categories, namely, food infl ation, footwear and textile infl ation, housing and construction infl ation. Accordingly, four vectors have been formulized to capture the determinants of overall infl ation and its different categories with particular focus on remittances. The study employed Johansen (1990) and Johansen & Juselius (1990) cointegration technique to check the existence of long run relationship between remittances and infl ation. Vector Error Correction technique is further applied to examine the extent and direction of relationship between variables and to check the stability of models. The results indicated the existence of one cointegrated vector for all equations. Moreover, remittances, money supply and real per capita income are found to have positive impact on inflation and its different categories. The results revealed that among different inflation categories food infl ation is most effected and housing & construction inflation is least effected by remittances. Budget deficit is significant in reducing foot wear and textile infl ation only. On the other hand trade openness is effective in reducing all types of infl ation by same magnitude and strength. Given the infl ationary nature of remittances it becomes necessary for government o channelize the remitted funds into productive investment to avoid surge in demand pull inflation. JEL Classification: E31

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