The Relationship between Inflation and Economic Growth in Indonesia: A Time Series Approach

Abstract

Aims: This empirical research aims to provide insight regarding the nexus between inflation and economic growth in Indonesia, while simultaneously controlling for the impact of capital formation and population growth.  Methodology: This research relies on time-series data spanning from 1985 to 2023. All the data estimated were obtained from the World Bank. Inflation is proxied by the Consumer Price Index (CPI). The Autoregressive Distributed Lag (ARDL) Bounds testing technique is utilized to examine the dynamic relationships, as well as the Toda-Yamamoto (TY) test for unraveling the direction of causal linkages.  Results: CPI is negatively associated with economic growth in Indonesia during the sample period, indicating the damaging impact of inflation. Higher inflation rates hamper business activities and purchasing power parities, and consequently, decline total output growth. Regarding control variables, gross fixed capital formation and the working-age population are positively associated with economic growth as expected. The results obtained from the TY test signify bidirectional causality between inflation rates and economic growth. Conclusion: Following the empirical findings, it is crucial to maintain inflation rates at a low level to spur economic growth.