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ISSN 1022-4734 JUJSS Vol. 33, 2016, pp. 79-94 An Empirical Study on the Relationship between Industrial Production and Consumer Price Index in Bangladesh Md. Tasnimul Hasan Department of Statistics, Comilla University, Kotbari, Comilla Bangladesh Humayun Kiser Department of Statistics, Comilla University, Kotbari, Comilla Bangladesh Md. Tareq Ferdous Khan Department of Statistics, Jahangirnagar University, Savar, Dhaka Bangladesh Abstract Recently Bangladesh has been promoted to lower-middle income country according to the World Bank’s estimates of Gross National Income per capita (GNI). To look into the next stair of the economic status, Bangladesh needs to work for waxing the economic growth. However, tackling the fluctuations on production, employment, consumer price index (CPI) used to measure inflation and international trade which are considered as the key components of economy, would be onerous. This paper studies the relationship between CPI and industrial production and hence delineates the effect of inflation on industry level production by employing Error Correction Mechanism, Granger Causality analysis. The study also provides the forecasted industrial production using seasonal dummy variable regression model. The data from January 2002 through June 2013 is used on the mentioned series to meet the objective of the paper. The empirical analysis reveals a positive long-run relationship between consumer price index and production and existence of bilateral causality between CPI and production. Keywords: Cointregation, Error Correction Model, Causality Analysis, Forecasting. 1. Introduction Inflation and productivity both has significant impact on economic growth like higher rate of inflation has adverse effects on the macroeconomic variable production but mild inflation is auspicious to production. Rising price, increase the profit expectation of the producers. But, hyperinflation reduces the production by slowing down capital accumulation and discoursing producers to invest in production. Indeed, hyperinflation and fluctuation in production resulting from hyperinflation would be lead to increase the production cost. To maintain the production cost producers may propose extensive cuts in the budget can lead to create unemployment problem, reduce working hours and wages of workers, compromise in product quality. Because of declined income, people cannot buy sufficient goods like before from the market which affect the production JUJSS Hasan, Kiser and Khan directly. Inflation impose higher tax rate on corporate profit which disrupts investment plans and affect productivity. In other way, higher productivity allowing cost reduction that flow through to product process and thereby reduce inflation. But, high level of production can lead to uncontrolled levels of consumption and rapid inflation. Since 1990s, radical changes have been taken place in the industrial sector of Bangladesh because of economic development and reforms which provides opportunities for both domestic and foreign investors. Investment not only increases the production but also open the windows of employment by generating new job sectors. 2. Literature Review on Inflation and Economic Growth Several researchers from both developing and developed countries have studied the nexus between inflation and productivity. Their empirical analyses reveal opposite scenario, while some studies provide suggestion in favor of negative relation between inflation and productivity, on the other hand, some studies do not support the negative relationship. Barro (1995) investigated the relationship between inflation and economic growth for more than 100 countries from 1960 to 1990. His empirical analysis suggested that the estimated relationship between inflation and economic growth is negative. On the other hand, Smyth (1995a, 1995b) concluded that there is no causal relationship between productivity and inflation on the basis of annual data for the period 1951-1991 for Germany and 1955-1990 for USA respectively, Malla (1997) conducted an analysis for Asian countries and countries belonging to the Organization for Economic Cooperation and Development (OECD) separately. After controlling for labor and capital inputs, the estimated results unveiled for the OECD countries that there exists a statistically significant negative relationship between economic growth and inflation. However, the relationship was not statistically significant for the developing countries of Asia. 80 An Empirical Study on the Faria and Carneiro (2001) investigated the relationship between inflation and economic growth of Brazil. Analyzing a bivariate time series model with annual data for the period between 1980 and 1995, they found that there exists a negative relationship between inflation and economic growth in the short-run, but inflation does not have any effecton economic growth in the long run. Ahmed and Mortaza (2005) used annual data of real GDP and CPI for the period of 1980 to 2005 for Bangladesh and referred that there exists a statistically significant long-run negative relationship between inflation and economic growth for Bangladesh. In neoclassical views, inflation increases economic growth by shifting the income distribution in favor of higher saving capitalists. This increases saving and thus economic growth. Moreover, Keynesians also said that inflation may increase growth by raising the rate of profit, thus increasing private investment. Mallik and Chowdhury (2001) examined the short-run and long-run relationship between inflation and economic growth for four South Asian economies including Bangladesh, India, Pakistan, and Sri Lanka. Applying co-integration and error correction models to the annual data they found the relationship between inflation and economic growth was positive and statistically significant for all four countries. Some other empirical studies found no relationship between inflation and economic growth. One study by Sidrauski (1967) indicates that inflation has no relationship with growth in the long run. In addition to Sidrauski, Bruno and Easterly (1995) have shown insignificant relationship between inflation and economic growth.The other critics argued in the context of the statistical point of view that productivity growth and inflation have different order of integration (Sbordone and Kuttner 1994, Cameron,Hum and Simpson 1996, Tsionas 2001, 2003). These studies claim inflation is non stationary and productivity growth is stationary and therefore there cannot be long run relationship. 3. Objective of the Study The main objective of this study is to explore a statistical relationship between industrial production and CPI in Bangladesh. The nature of the relationships, whether positive or negative in the short run as well as in long run and examines the effect of 81 JUJSS Hasan, Kiser and Khan CPI on industrial production. This paper also analyzes the causality issue, direction of causality, short-run and long-run equilibrium between industrial production and CPI. Finally, it provides the forecasted values of the industrial production. 4. Limitation of the Study Prior to 2002, the CPI is measured on the basis of the base year 1985-86 and later on for the years 2002 to 2013, 1995-96 base year is used and finally from 2013-14 fiscal year, base year of all economic indicators of Bangladesh have been shifted to 2005-06. As a consequence, this study uses the data of the series under study from 2002 to 2013 to keep consistency in the base year. Moreover, the GDP splits into various sectors such as agriculture and forestry, industrial production (mining and quarrying, industry, electricity, gas and water supply), service sector. This paper has taken only industrial production into consideration among the segments of GDP and thus every result is concentrated on it rather than the whole GDP. 5. Data and Methodology 5.1 Data The empirical analysis has been carried out by using monthly data for consumer price index (CPI, base: 1995-96=100) and quantum production index (QPI, base: 1988- 89=100) from January, 2002 to June, 2013. The CPI measures changes in the price level of consumer goods and services purchased by households. On the other hand, QPI is the output of all industries; manufacturing, mining and quarrying, electricity. The data were collected from monthly statistical bulletin, published by Bangladesh Bureau of Statistics (BBS, 2002-2013). All variables are then transformed to their logarithm, often used to stabilize the variance of a series. In recent Fiscal years, industrial production contributes about 20 percent in the total GDP (BBS, 2015.) The statistical packages such as Eviews, Stata, gretl and Microsoft Excel provide an enormous support to complete the analysis of the study. 5.2 Methodology The steps and affiliated methods to examine the relationship between industrial production and inflation are summarized below: 82 An Empirical Study on the To test the stationarity of the series under study, unit root test is used and performed by graphical method, Augmented Dickey-Fuller (ADF) test(1979, 1981) and Kwiatkowski–Phillips–Schmidt–Shin (KPSS) test (1992), including constant term and trend term as exogenous variables. In checking cointegration between inflation and production, Engel-Granger (EG) or Augmented Engel-Granger method (AEG, 1987) and Johansen method (1990) were employed. Primarily, to know the effect of CPI and QPI on each other, two separate simple linear regression models of logarithm of CPI on logarithm of QPI and vise-versa are