Testing the Classical Inflation Theory in Pakistan

Abstract

The study is about the examination of the classical theory of inflation in Pakistan. The data covered, the time period from 1972 to 2020. Time series data is used and collected from World Bank. The ARDL model estimation technique is used to analyze the data. The study shows a research gap based on testing the classical inflation theory in Pakistan which is different from previous related studies. The novelty of this research is to test the positive and direct linkage of doubling the money supply will double the price level in the case of Pakistan believing the classical model of inflation. The stationarity of data is checked through the unit root test. The results show that there is a positive relationship between nominal money supply and inflation in Pakistan, as classical believe that doubling the money supply will double the price level and the value of money becomes half. The findings of the study support that classical inflation theory is valid in the case of Pakistan. Inflation is taken as a dependent variable as a proxy of GDP deflator and a list of independent variables are such as per capita income, nominal money supply, interest rate, taxes, and government current expenditures. The empirical, theoretical, and historical facts are supporting this study. The study has explored the existence of inflation in Pakistan. It is observed that inflation is a monetary phenomenon and it is connected with the money supply which leads to an increase in the general price level. In order to curtail inflation government should control the money supply which will help to reduce prices.