Does Financial Development Induce Inflation? ARDL Based Evidence from Pakistan

Abstract

The study explores the dynamic association of financial expansion in curbing inflation and thereby assessing the general economic welfare strategies employing data over 1974-2016 for Pakistan. Econometric sophistication rests in the employment of autoregressive distributed lag (ARDL) bound test of co-integration with short run disequilibrium models. The outcome corroborates that inflation and financial development with other controlled variables are co-integrated. The findings also corroborate that broad money, domestic credit to private sector, government expenses, and personal remittances are crucial indicators of financial development and diversely linked with inflation over the period of analysis. Specifically, broad money and government expenses corroborate a long run impact on inflation conforming to the idea of quantity theory of money neutrality. Likewise, domestic credit has shown noteworthy but low positive drive to inflation in long time of span, albeit domestic credit has insignificantly linked to inflation for the short span of time. These findings inter alia imply for the promotion of sound domestic banking/financial sector for credit market and new strategies for controlling the broad money/government expenses to curb the unintended rampant level of inflation in Pakistan.