Abstract:
Monetary tools, money supply, and exchange rates play a significant role in a
country's growth and significantly impact its development trajectory. Sri Lanka is
currently concerned about high inflation. Inflation is a monetary phenomenon, and
it has been caused by monetary policies in several nations. The relationship
between money supply and inflation has been a topic of enduring interest and
debate in economics. This paper aims to investigate the examine the causal
relationship between money supply and inflation. This empirical study analyses
short run and long run relationship between inflation and money supply, during
1978-2023 in Sri Lanka. Annual data for the period 1978-2023, obtained from
annual reports of Central Bank of Sri Lanka were used for this study. This study
employs Autoregressive Distributed Lag (ARDL) Bounds test to identify the long run
and short run relationship between inflation and its causes. The findings of the study
indicate that nominal exchange rate has both short run a nd long run relationships
with inflation while nominal money supply and nominal interest rate have a long run
relationship with inflation but not a short run relationship. According to results of the
study, money supply and inflation have a positive relationship in the long run. Thus,
classical quantity theory of money and Cambridge equation as well as monetarist
view on inflation is valid in the long run in Sri Lanka. When considering the nexus
between inflation and interest rate, it is concluded to have a positive relationship in
Sri Lankan context. A positive relationship can be seen in between nominal
exchange rate and inflation in both short term and long term. Therefore, in order to
achieve price stability, proper control over monetary policy and proper management
of e xchange rates are important.
