Monetary Dynamics in Nepal: An ARDL Approach to Price Level, Income, and Money Supply Interlinkages

Abstract

Purpose: The relationship between price levels, money supply, and output has long been a subject of macroeconomic research, yet findings remain inconsistent, with differing views among economists. This study examines whether long-run and short-run relationships exist between price levels (CPI), real broad money supply (M2), and real GDP (GDP) in Nepal. Design/Methodology/Approach: Using annual data from 1974 to 2021, this study employs the Autoregressive Distributed Lag (ARDL) model, cointegration analysis, error correction mechanisms, and causality tests, with GDP as the response variable. Findings: The results confirm a long-run cointegrating relationship, with M2 and CPI having a positive influence on GDP. In the short run, inflation has a negative effect on output, while an increase in the money supply has a stimulating impact. Causality tests reveal a bidirectional relationship between M2 and price levels, while unidirectional causality runs from the CPI to GDP and from GDP to M2. Implications/Limitations: These findings highlight the non-neutrality of money in the short term and its strategic role in long-run economic performance. The study provides evidence-based guidance for inflation targeting and monetary-fiscal coordination to foster macroeconomic stability in Nepal. However, the study is limited to the Nepalese context and may not be generalizable to other economies. Originality/Value: By applying robust econometric techniques, this study highlights the critical role of price stability in promoting economic growth and controlling inflation in Nepal, providing policymakers with valuable insights.

Keywords:CointegrationGDPincomeBroad money supplyprice level