Study of Inflation in India: A Cointegrated Vector Autoregression Approach

The spate of persistent inflationary pressure experienced in the post liberalisation era in India throws light on the fact that the causes of inflation in India have undergone tectonic changes. The present study therefore aims at empirically identifying the determinants of inflation in India. In a Cointigrated Vector Autoregression (VAR) framework, the empirical estimation is carried out. The Error Correction Mechanism (ECM) of the cointegrated variables is also carried out. The Impulse Response Function (IRF) of the cointegrated VAR system shows that there is a lag in the response of inflation to the changes in the other variables in the VAR system. The Fixed Error Variance Decomposition (FEVD) shows that, the inflation in India is a mix of demand and supply side factors. The stabilization policies should therefore focus on both demand control as well as supply management. Also considering the lag in the impact of the explanatory variables the stabilization policies should become more pro-active.