Testing Relationship between Inflation, M2 (Broad Money) and Private Sector Credit in Pakistan

This research paper examines the impact of inflation with M2 (broad money) and private sector credit in Pakistan and helps to forecast inflation and its affect in Pakistan during the year 1975 to 2008. Inflation is defined as too much money chasing too few goods. Inflation leads to high prices and that affect all mechanism of the market. The rate of inflation is an important macroeconomic indicator that can affect the economic growth. Inflation was in lime light throughout the year, as the rise of global inflation witnessed during the most part of 2008. This paper finds out that an increase in money supply over long-run results in higher rate of inflation. Thus it establishes that inflation is essentially a monetary phenomenon. The results indicate that monetary factors have played a dominant role in recent inflation. Changes in wheat support price influence inflation in short-run, but not in long-run. Thus by using data from 1975- 1976 to 2007-2008 period, applying Augmented Dickey-Fuller tests, its finds that the most important determinants of inflation in 2007-2008 were adaptive expectations private sector credit and rising import prices whereas fiscal policy's contribution to inflation was nominal. Analysis of price multiplier indicates that increase in wheat procurement prices have relatively small effects on overall price levels.