Inflation and openness in India: an asymmetric approach

Abstract

This paper examines the dynamic relationship between inflation and openness from 1970 to 2014 in the Indian context. In the first of its kind, this paper investigates the relationship within a nonlinear framework by employing NARDL cointegration test due to Shin, Yu, and Greenwood Nimmo (2014). The empirical results show that there is asymmetry in the relationship between openness and inflation both in short-run as well as in long-run. However, overall a positive relation (though weak) holds between inflation and openness and hence refutes well known Romer (1993) hypothesis that inflation falls with openness. The results further showed a positive relation between inflation and other variables in the study. The overall response of inflation towards the positive and negative changes in explanatory variables differed significantly.

Keywords:

• inflation
• openness
• asymmetry
• cointegration
• NARDL
• India

Acknowledgements

We thank Greenwood Nimmo for providing estimation code for NARDL model and two anonymous referees of this journal, for useful inputs. We would also like to thank Reshma Aguiar for editorial assistance as well inputs on an earlier version of the paper. Usual disclaimer applies.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1. There are two studies which have been carried out in case of Indian context namely Joshi and Debashish (2010) and Neeraj, Kapoor, and Poddar (2014), but these studies have ignored the presence of asymmetry in the relationship.

2. Openness does not have any universally accepted definition. Its different aspects make construction of one index difficult. Common ‘single indices’ only measure economic dimension of openness like trade openness, the IMF’s restrictions measurement, Chinn-Ito index, etc. ‘Synthetic indices’ measure economic, social, political and environmental dimensions of openness like A.T. Kearney/Foreign Policy Globalization (KFP), KOF, Maastricht Globalization Index, New globalization index etc. There are various shortcomings of each group of indexes but the most robust obstacle is a lack of data (Goldberg and Pavcnik 2007). In this study, we are looking at the economic dimension of openness thus, we choose trade ratio as a measure of openness. This index for measuring trade openness is the ratio of trade (sum of export and import) to the Gross Domestic Product (GDP) of the country. The trade openness of countries depends on trade policy (restriction on trade) as well as the geographical and economic characteristics of a country.

3. According to the Pantula principle, test should be set up as follow. Start with the estimated model that includes a constant and a trend. If a unit root is rejected here it is possible to stop. Asymptotically it can be shown that the series does not have a unit root. If it is not possible to reject, continue to a model with a constant. If a unit root is rejected it is possible to stop testing. If the null of a unit root is not rejected it is possible to continue and exclude the constant. The latter is seldom a good strategy if the variable is obviously non-stationary (Sjö 2011).

4. However, at times global oil price have decreased, but the pass-through has been either absent or very limited. Moreover, studies on the effect of oil price on domestic inflation also suggest that the nature of effect is asymmetric (see among others Hamilton and Herrera 2001; Davis and Hamilton 2003).

Additional information

Notes on contributors

Taufeeq Ajaz

Taufeeq Ajaz is a doctoral candidate at the School of Economics, University of Hyderabad, Hyderabad, India. His research interests include monetary economics, empirical macroeconomics and applied time series analysis.

Md Zulquar Nain

Md Zulquar Nain is with Department of Economics, MANUU, Hyderabad as Assistant Professor and a doctoral candidate at School of Economics, University of Hyderabad, Hyderabad, India. His research areas are International Economics, Applied Time series analysis and Monetary Economics.

Bandi Kamaiah

Bandi Kamaiah is Professor and Dean School of Economics, University of Hyderabad, Hyderabad, India. His research areas include Monetary Economics, International Economics, Financial Economics, Econometrics and Applied time series.