Empirical Study of Money Supply and Inflation in India Using Econometric Techniques

According to Monetarist Milton Friedman (1970), Inflation is always and everywhere a monetary phenomenon. There is a lack of consensus among researchers regarding the stimulus of changes in money supply over price level. Even though a very large number of researches conducted to understand the exact nature of relation between money supply and inflation, there seems to be no final conclusion which can be relied upon for policy formulation. The present study intends to find out the causal relationship between inflation measured on Wholesale Price Index (WPI) and a host of its determinants like Gross Domestic Product (GDP), money supply, interest rate and velocity of money in Indian context using time series data set of 46 years starting from 1970-71 to 2015-16. The findings suggest that there exist bi-directional Granger causality between velocity of money and inflation, unidirectional causality between interest rate and inflation, GDP and inflation while no causality has been detected between money supply and inflation. These results are further confirmed based on Impulse response function and variance decomposition. The results support the theoretical arguments of monetary theories