The Relationship between Inflation and Economic Growth in Nepal: A Cointegration Analysis

Abstract

This paper examines the long-run and short-run relationship between inflation and economic growth in Nepal using annual data for 1975–2023. We estimate a multivariate Vector Error Correction Model (VECM) over GDP growth, the consumer and wholesale price indices, remittances, broad money, and government expenditure, and extend it with a Hansen–Seo threshold specification to test for non-linearity. Three results stand out. First, the Johansen procedure identifies multiple cointegrating vectors among the variables. Second, the linear long-run coefficient on consumer-price inflation is small and statistically insignificant once the other variables are jointly controlled for, which we interpret as a signal that the underlying relationship is non-linear rather than benign. Third, the threshold analysis identifies an endogenous break point at roughly 9.5 percent annual CPI inflation: below this rate inflation is broadly neutral or mildly growth-supportive, while above it the short-run inflation effect on growth roughly doubles and adjustment slows. The threshold sits within the band identified for developing economies (Sarel, 1996; Khan & Senhadji, 2001), placing the Nepalese case inside the international evidence on a negative or non-linear inflation–growth nexus. For monetary policy, the results support keeping inflation comfortably below the threshold, with a working target band of around 5–7 percent.