The Impact of Trade Openness on Inflation: Evidence from Six South Asian Countries from 1980 to 2016

Abstract

In recent four decades, the inflation rate for south Asian countries (Including India, Nepal, Pakistan, Sri Lanka, Bhutan, and Bangladesh) fluctuated between -18.10 and 26 range which has a huge difference with the natural rate of inflation. Meanwhile, the level of trade openness has been rapidly increased in this region. Therefore, this study attempts to examine the impact of trade openness on inflation. Data for the above south Asian countries are collected to assess the effect of trade openness on inflation. The study uses a panel data form for the time period 1980 to 2016. In further, the study includes money and quasi-money, exchange rate, gross domestic saving, and domestic credit providing by the financial sector as explanatory variables which almost all have a significant impact on the inflation rate of selected countries. The main objective of this study is to examine the existence of Romer’s hypothesis in these countries. For this purpose, Fixed Effects, and Random Effects models have been applied to data, and the results show a significant and positive effect of trade openness on the inflation rate. Therefore, the study suggests to the governments of these countries that the negative effects of openness regarding inflation have to be considered and the policymakers should be aware of the side effects of openness of trade.