Long run/Short run Relationship between Inflation and Oil Price in Sri Lanka

Abstract

The volatility in the oil prices has the implications towards the macro economic variables of developed and developing countries. Recent highs in the world oil market are causing for possible slowdowns in the economic performance of countries. This study examines the long run / short run relationship between inflation and crude oil prices to give some guidelines for possible economic implications. Colombo Consumer Price Index was used as the proxy for inflation. Deductive approach has employed using the secondary data over the period from January 2008 to April 2018. Augmented Dickey Fuller Test was used to identify the stationary of the data set. Results suggested that there is a unit root in level series and thus the first difference series of both variables were used for the analytical purposes. Initially, to identify the long run relationship, Johansen-Juselius (1990) cointegration test was used and the results revealed that there is a significant long run negative relationship between Colombo Consumer Price Index and crude oil prices. Furthermore, to identify the short run relationship, Impulse Response Analysis and Variation Decomposition Analysis were used. Results suggested that there is a short run relationship between above variables too. Further, Impulse Response Analysis suggested that the shock of the oil prices impact to the Sri Lankan economy through the Colombo Consumer Price Index was started after 3 months and more than 8 months goes to become to the normal situation. The empirical findings of this study is helpful for government policy makers, financial managers, financial analysts and other interested parties who is dealing with the Sri Lankan economy. Very recently, the government policy makers have taken steps to revise the fuel pricing formulae on a bimonthly basis. But there want to be a much issue if those formulae were revised on a trimonthly basis.