IBS 4394 Financial Forecasting

Impact of Inflation on GDP: Indonesia Example

Tuğçe Akın 2019432018, Derya Eşme 2019431045, Özkancan Bahar 2017432126, and

Ömer Taha Yılmaz 2020432088

Department of Business, Dokuz Eylul University

Abstract: In this study, we aim to investigate the impact of changing inflation values on gross
domestic product values in Indonesia. For this purpose, firstly we focused on the previous
findings in our literature review. In the second part, we used an analytical approachon a sample
of data over the period of 2006 to 2022 the relationship. Overall, our results showed that the
inflation and gdp are positively correlated, this claim will be supported by a regression analysis.

Keywords: Inflation, GDP, Indonesia

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Introduction

One of the most important economic indicators is inflation, which affects a country’s GDP (gross
domestic product). Economists and policymakers must comprehend this link to support
sustainable economic growth. In this study, we investigate how Indonesia's GDP which is a
dynamic and quickly changing economy, is affected by fluctuations in inflation rates.
We conduct a detailed literature review to position our study within a larger framework of
current economic theories and prior findings. We use a statistical approach to investigate the
relationship between GDP and inflation rates using data from 2006 to 2022. Regression analysis
confirms our findings, which show a positive correlation between GDP and inflation in
Indonesia. Our analysis provides a detailed understanding of the economic dynamics at work in
addition to the ways that inflation affects Indonesia's growth.

1. Literature Review

There are many studies examining the relationship between GDP and inflation worldwide and in
Asia-middle east countries specifically. Tien, N. H. (2021) conducted a study in Vietnam in 2001
to understand the relationship between inflation and GDP growth. The research found that
moderate inflation below 6% has a positive effect on GDP growth, while inflation above this
threshold has a negative impact. Gokmenoglu, K., Azin, V., & Taspinar, N. (2015) carried out a
study in Turkey from 1961 to 2012 to analyze the relationships between oil prices, inflation,
GDP, and industrial production. The study revealed a unidirectional causal relationship between
oil prices and industrial production in Turkey. The study by Salamai, A. A., Faisal, S. M., &
Khan, A. K. in 2022 aimed to understand the relationship between Saudi Arabia’s GDP and
inflation rate from 1969 to 2020. Using econometric models, the researchers found no significant
relationship between GDP and inflation in Saudi Arabia over the period studied, suggesting that
other variables may have a greater influence on Saudi GDP growth. Hossin, M. S.'s 2015 study
focused on the relationship between inflation and economic growth in Bangladesh from 1961 to
2013. The research found a statistically significant long-term negative relationship between

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inflation and economic growth in Bangladesh. It also indicated that economic growth can lead to
moderate inflation, while higher inflation rates tend to stifle GDP development. The findings
suggest that low or moderate inflation may support economic stability and investment, but
inflation over a certain level has a negative effect on growth. Inflation, Unemployment, and
Economic Growth in Nigeria (1980-2014) - Darma & Onimisi, 2017. Examines the relationship
between Nigeria's economic growth, inflation, and unemployment. Nigeria's inflation rate
reached a record high of 47.56% in January 1996 and a record low of -2.49% in January 2000.
Unemployment rate saw an all-time high of 23.90% in the fourth quarter of 2011 and a record
low of 5.30% in the fourth quarter of 2006. Study used secondary data covering 34 years from
1980 to 2014. ARDL bound test estimations showed no lasting relationships between the
variables. VAR estimations indicated no meaningful correlation between unemployment and
economic growth. Encourages government to support rural farmers to diversify their businesses
to lower unemployment and boost productivity. Unemployment, Inflation, and Impact of GDP in
India by Xia examines the rate of inflation and unemployment in the Indian economy over six
years to calculate the trade-off between unemployment and inflation. Contends that intentionally
managing low levels of employment typically results in higher inflation. First theory: 76%
variance in employment rate as a function of inflation and GDP. Second theory: GDP and
unemployment rate have a 96% impact on the variation in the inflation rate. Third theory: 95%
variance in GDP impacted by both unemployment and inflation. Demonstrates the impact of
GDP, unemployment, and inflation on each other. The first study by Omoke Philip Chimobi
aimed to determine the relationship between inflation and economic growth in Nigeria. The
results indicated a unidirectional causal relationship from inflation to economic growth at lag
two and lag four but did not specify if the relationship was positive or negative. Previous
literature suggests high inflation is unfavorable for economic growth. The second study by
Ekinci, Tüzün, & Ceylan focused on the relationship between inflation and economic growth in
inflation-targeting countries. It used a threshold dynamic panel data model to determine the
impact of inflation on economic growth. The study found that the threshold inflation rate in
inflation-targeting nations is 4.182%, below which the relationship between inflation and
economic growth is not significant, but above which inflation hurts economic growth. This
suggests an unbalanced and nonlinear relationship between inflation and economic growth,
emphasizing the importance of the inflation targeting strategy.

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Umair, M., & Ullah, R. analyze the impact of GDP and inflation on the unemployment rate in the
Pakistan economy from 2000 to 2010. Inflation in Pakistan averaged 8.04 percent, with a peak of
37.81 percent in December 1973 and a record low of -10.32 percent in February 1959. Pakistan's
GDP growth rate averaged 5.0 percent from 1952 to 2010, with a high of 10.2 percent in FY
1953-54 and a low of -1.8 percent in FY 1951-52. Despite a 5 percent annual GDP growth rate
since 2005, Pakistan's economy struggles to keep up with population growth due to political
instability, corruption, and lack of law enforcement. The research found that inflation has an
insignificant impact on GDP and unemployment, with a negative correlation and limited
variation. The study by Jude, C., E., & Muhammad, K. examines the connection between
inflation and economic growth, emphasizing the effect that inflation may have—positive or
negative—on growth. Data from 102 nations were examined, and factors including GDP per
capita, openness, investment, government spending, and population growth were all included.
The results imply that certain macroeconomic factors in a particular nation influence both the
ideal amount of inflation and its determination. An Examination on the Determinants of Inflation
by Lim, Y. C., & Sek, S. K. defined inflation as a sustained increase in the general price level,
leading to a decline in purchasing power. The study used annual data for 28 countries between
1970 and 2011 and focused on high and low inflation countries. The results indicate a significant
negative long-run effect of GDP growth on inflation in low inflation countries. Increases in
money supply have a long-run negative impact on inflation in high inflation countries. National
expenditures also have a long-run effect on inflation in high inflation countries. All exogenous
variables except national expenditures have a significant short-run effect on inflation in low
inflation countries. Imports of goods and services have a negative effect on inflation in low
inflation countries.In summary, the study reveals significant determinants of inflation and
suggests that controlling variables with negative effects can increase economic stability. Saymeh
and Abu Orabi's study examines the impact of GDP, interest rates, and inflation on Jordan's real
economic development between 2000 and 2010. Its goal is to evaluate whether economic
expansion can both preserve natural resources and satisfy society's growing expectations.
According to the study, interest rates have an autoregressive conditional variance effect, on the
other hand, real growth rates and GDP both influence inflation and interest rates, respectively.
The results point to a feedback loop between actual growth rates and interest rates. The report

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emphasizes Jordan's difficult prospects for economic growth because of adverse outside
influences and sociopolitical instability in the area.

2. Data and Methodology

Based on the previous studies, it is expected that the inflation are related to the GDP in
Indonesia. The study hypotheses are listed as follows:

H0: Inflation has no effect on Indonesia’s GDP value.

H1: Inflation has an effect on Indonesia’s GDP value.

2.1. Data

In this paper, we have performed an analysis on inflation and GDP data on a yearly basis from
2006 to 2022 on a sample provided by Kaggle.com. We have 17 observations, and we plan to
perform a forecasting analysis for another 4 observations during the next year, 2022.

2.2. Methodology

The main purpose of our study is to investigate whether inflation affects the GDP. There is no
other control variable, just dependent and independent variables. In this study, we performed
correlation analysis followed by basic regression analysis using Eviews 12 (student version). We
used the OLS methodology.

Y = a + B1X + Er

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Where X is the independent variable (inflation), Y is the dependent variable (GDP), a is the
intercept, and Er is the error term.

3. Empirical Results and Discussions

3.1. Correlation

Table 1. Least Squares Results

In the observed data here, we claim that there appears to be a positive correlation between GDP
and inflation, as indicated by the positive coefficient for inflation (0.077875) and its statistical
significance (p-value of 0.0004). This indicates that throughout the sample period of 2006 to
2022, greater GDP levels are often correlated with higher inflation rates.

Our model is better fitted when its R-squared and Adjusted R-squared values are higher. Since
inflation determines 0.57 percent of the dependent variable, we may claim that this model is
neither particularly good but neither poor either. Also, this model has a positive autocorrelation
because the Durbin-Watson stat value is less than 2.

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 Table 2. Heteroskedasticity Test Results

The likelihood of Chi-Square has a value larger than 0.05. It indicates that the data set is
homoscedastic, which makes it suitable for a well-designed regression.

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Series: Residuals
6 Sample 2006 2022
Observations 17
5
Mean 7.38e-16
4 Median -0.267721
Maximum 2.476167
3
Minimum -1.105783
Std. Dev. 1.087640
2
Skewness 1.166314
1 Kurtosis 3.345642

0 Jarque-Bera 3.938772
-1.5 -1.0 -0.5 0.0 0.5 1.0 1.5 2.0 2.5 Probability 0.139543

The probability is 0.139 so it is greater than 0.05. We will accept the null hypothesis and reject
the alternative hypothesis.

GDP INFLATION
7 GDP 1 0.75833362...
INFLAT... 0.75833362... 1
GDP and inflation have a 0.76 correlation. It indicates a favorable link between GDP and
inflation. Put differently, GDP will rise in response to rising inflation and fall in response to
falling inflation.

3.2. Forecast
3.6
Forecast: GDPF
3.2 Actual: LOG(GDP)
Forecast sample: 2006 2022
2.8 Adjusted sample: 2007 2022
Included observations: 16
2.4
Root Mean Squared Error 0.096193
2.0 Mean Absolute Error 0.067839
Mean Abs. Percent Error 5.083339
1.6 Theil Inequality Coef. 0.033021
Bias Proportion 0.416330
1.2
Variance Proportion 0.001779
0.8 Covariance Proportion 0.581891
Theil U2 Coefficient 0.969800
0.4 Symmetric MAPE 4.847346
2008 2010 2012 2014 2016 2018 2020 2022

GDPF ± 2 S.E.

The comparatively low error measures (RMSE, MAE, MAPE, and SMAPE) show that the
forecast model has a respectable degree of accuracy. The GDP projections' upward trend is
consistent with the anticipated expansion of the economy. To increase accuracy, though, the bias
proportion raises the possibility that the model has some systematic inaccuracy, which has to be
2,400

2,000

1,600

1,200

800

400

-400
2006 2008 2010 2012 2014 2016 2018 2020 2022

GDP GDP_F GDP_SE

Inflation RESID year

fixed.

The analysis's finding of a positive link between GDP and inflation suggests that inflation
significantly affects GDP growth. This relationship should be taken into account by policymakers
when developing economic strategies. In order to create policies that support stable and

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sustainable economic growth, it is essential to comprehend how inflation affects different
economic variables.

4. Conclusions and Policy Implications

This paper aims to identify the effect of inflation on GDP in Indonesia. To achieve this, we
applied OLS regression to time series data of inflation and GDP spanning from 2006 to 2022,
without incorporating other control variables. The results generally indicate that inflation is a
significant determinant of GDP in Indonesia. The model's R-squared and Adjusted R-squared
values suggest that while the model isn't perfect, it's reasonably effective, explaining 57% of the
variance in GDP. However, the regression model exhibits positive autocorrelation. The dataset
shows homoscedasticity, which supports the reliability of the regression results. With a
probability of 0.139, we accept the null hypothesis and reject the alternative hypothesis, and
there is a positive correlation between GDP and inflation.

Inflation significantly impacts Indonesia’s GDP. Understanding how inflation affects purchasing
power, unemployment, income distribution, international power, financial markets, interest, and
monetary policies is crucial for shaping Indonesia’s future. Therefore, it is essential for
governments and policymakers to consider these factors to foster a sustainable and prosperous
economic environment for Indonesia. Additionally, Indonesia should strive to establish itself as a
stable and sustainable economy on the global stage.

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5. References

Chimobi, O. P. (2010). Inflation and Economic Growth in Nigeria. Journal of

Sustainable Development, 3(2), pp. 159-166.

Darma, N. A., & Onimisi, A. M. (2017). The Analysis Of The Relationship

BetweenInflation, Unemployment And Economic Growth In Nigeria (1980-
2014). 5(5), 106-114. doi:10.14738/abr.55.3135.

Ekinci, R., Tüzün, O., & Ceylan, F. (2020). The relationship between inflation
and economic growth: Experiences of some inflation targeting countries.
Romanian Academy, National Institute of Economic, 24(87), pp. 6-20.

Gokmenoglu, K., Azin, V., & Taspinar, N. (2015). The relationship between
industrial production, GDP, inflation and oil price: the case of Turkey. Procedia
Economics and Finance(25), pp. 497-503.

Hossin, M. S. (2015). The relationship between inflation and economic growth

of Bangladesh: An empirical analysis from 1961 to 2013. Finance and
Management Sciences,(5), pp. 426-434.

Jude.C., E., & Muhammad., K. (2014). On the nonlinear relationship between

inflation. Research in Economics(68), pp. 133-143.

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Lim, Y. C., & Sek, S. K. (2015, July). An Examination on the Determinants of
Inflation. Journal of Economics, Business and Management, 3(7), pp. 678-
682. doi:10.7763/JOEBM.2015.V3.265

Salamai, A. A., Faisal, S. M., & & Khan, A. K. (2022). The relationship between
inflation and GDP with reference to oil based economy. International Journal
of Multidisciplinary Research and Growth Evaluation.

Saymeh, A. A., & Abu Orabi, M. M. (2013). THE EFFECT OF INTEREST RATE,
INFLATION RATE, GDP, ON REAL. Asian Economic and Financial Review, 3(3),
pp. 341-354.

Tien, N. H. (2021). Relationship between inflation and economic growth in

Vietnam. Turkish Journal of Computer and Mathematics Education
(TURCOMAT)(14), pp. 5134-5139. doi:5134-5139

Umair, M., & Ullah, R. (2013). Impact of GDP and Inflation on Unemployment
Rate: A Study of Pakistan Economy in 2000-2010. International Review of
Management and Business Research, 2(2), pp. 388-400.

Xia, X. (2021). Unemployment, Inflation, and Impact of GDP in India. Atlantis

Press, 166, pp. 641-647.

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