Application of the P-Star model for measuring inflationary pressure in Bangladesh

According to this paper the P* model (an economic model) has gained wide popularity in recent years to explain inflation dynamics, especially in developed countries. The current study attempts to apply the P* model as an effective tool to measure inflationary pressure on the Bangladesh economy.

The fight against inflation requires effective policies to control undue rises in prices and credible tools to predict future movements in inflation and identify the causal factors. Covering annual data from 1980 to 2008 the study tries to test how the P* model works to analyse the Bangladesh economy and its forecasting ability through generating recursive forecasts. The results lend some ground for confidence in the use of P* models for gauging inflationary pressures in the Bangladesh economy.

It shows that rather than other traditions, the P-star class of models works smoothly due to its close link with the long tradition of mainstream monetary theory. The results show that the model performs relatively well with annual data and gives some further hints regarding the future rates of inflation. The price and output gap models fare consistently better than the velocity gap model which brings out the importance of non-monetary factors in explaining inflation dynamics in Bangladesh. These findings have implications for the monetary targeting policy framework currently pursued by the Bangladesh Bank. Thus the above results suggest that both velocity and output gaps are important determinants of changes in inflation in Bangladesh.

The paper argues that the P* models can influence policy analysis through its wide application. It will be helpful in analysing national income and in deriving macroeconomic implications of different monetary policy rules through estimating impulse response functions.