Food price dynamics and inflation in Sri Lanka

Food price contributes the largest share in the general price index in developing countries. Consequently, the nature of food price dynamics, global and domestic food price and volatility transmission influence the general price inflation. The main objective of the study is to examine food price dynamics and inflation in Sri Lanka for the period of 2003M1-2014M12 by focusing on two perspectives: i) long memory of food price inflation and ii) food price transmission. This study attempts to examine specifically (i) the long memory properties of food price dynamics, (ii) the transmission of global food price dynamics to domestic prices, (iii) the transmission of global food price volatility to domestic prices, and (iv) the spillover effects of domestic food prices on overall consumer price. Rescaled range statistic, Geweke and Porter–Hudak statistic, Local Whittle estimator, autoregressive fractional integrated moving average model and fractional integrated generalised autoregressive conditional heteroscedastic model were used to estimate the long memory parameter of the food price series. Cointegration technique, error correction models, Granger causality analysis, and impulse response function analysis (IRF) were employed to investigate the price transmission effects. The long memory analysis shows that all food price and volatility series possess long memory. The cointegration and causality analysis show that the global food price and volatility transmit significantly to the domestic prices. In addition, the results also reveal that the domestic food prices influence positively and significantly the overall consumer price. IRF analysis also shows that there is a positive shock of global food price on the domestic prices which lasts for longer periods. Hence, the policy makers are recommended to take into account food prices in computing core inflation which is used for monetary policy in Sri Lanka.