Effect of Contractionary Monetary Policy on Inflation in Bangladesh: A VECM Approach

Nurun Nahar Akhi


This study examines the impact of contractionary monetary policy on inflation in Bangladesh using time series data for 1987–2022. Money supply, interest rate, and exchange rate are taken as independent variables to show their effect on inflation. The ADF test is used to test the stationarity of the variables in the model, and all the variables are stationary at the first difference. As a result, Johansen’s co-integration techniques are used, revealing a co-integrated equation in the model. Therefore, the vector error correction model (VECM) is used for the estimation. The VECM estimation shows that the coefficient of error correction with the inflation rate as a dependent variable is negative and statistically significant at 5%, implying a robust long-run relationship between money supply, interest rate, exchange rate, and inflation rate. In the short run, bidirectional causality exists between the money supply and inflation only at the first lag. Moreover, the study found no overall short-run significant causality between the money supply, interest rate, exchange rate, and inflation. The novel approach of this study lies in its comprehensive analysis of the intricate relationship between monetary policy instruments and inflation dynamics in Bangladesh.


Keywords: contractionary monetary policy, inflation, vector error correction model.



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