An empirical analysis of remittance – inflation relationship in Bangladesh: post-floating exchange rate scenario

Workers’ remittance inflows have been rising significantly over the past decade for Bangladesh. They have become one of the most stable sources of foreign exchange earnings and emerged as a crucial issue for monetary and fiscal policy. In 2012, remittances contributed to 12.3% of GDP of Bangladesh while the contribution was 6.4% in 2003. Besides lowering poverty and stimulating economic growth through different microeconomic and macroeconomics channels, remittances like other massive capital inflows can induce inflation and appreciate the real exchange rate and thereby hurt the competitiveness of the tradable sector along the lines of the Dutch Disease phenomenon. In this paper, we have empirically tested whether growing remittances cause an inflation (Model 1) as well as food inflation (Model 2) in Bangladesh using monthly data over the time period July 2003- July 2013 (post - floating exchange rate scenario). We have considered two models as the pattern of expenditure varies by consumption categories suggesting that the effect of remittances may also vary across them. Monthly data is used to better represent the changes in inflation as it is well known that inflation changes occur very quickly in response to shocks. The reason for specifically concentrating on the post-floating exchange rate scenario comes from the fact that the impact of remittances on a economy depends on the exchange rate regimes and studies not controlling for regimes may be biased as suggested by Ball, Lopez & Reyes (2013). Johansen (1988) and Johansen & Juselius (1990) cointegration technique is used to determine the long run relationship between remittances and inflation. Then, a Vector Error Correction Model (VECM) approach is applied for estimating the direction, extent and significance of the relationship. The results of both the models show that remittance inflows cause an inflationary pressure in Bangladesh while the responsiveness of food inflation is almost two and half times higher than general inflation