Empirical Psychology Between Wholesale Price And Consumer Price Indices: The Case Of Pakistan

In a small open economy, the retail sector adds value with a lag to existing production and uses existing domestic production as an input. Therefore, demand side dynamics depend on the wholesale prices of the domestic goods, the prices of the imported goods, the nominal exchange rate, the level of indirect taxes, the marginal cost of retail production and interest rates. Hence, this mechanism provides a theoretical basis for causality from wholesale prices to consumer prices. Being motivated by this causal transmission mechanism, this paper tries to examine the causal relationship between wholesale prices and consumer prices in a small developing economy like Pakistan. Empirical methodology uses recently developed tests for the existence of a long-run relationship between wholesale prices and consumer prices. Typically, in applied analysis, testing for the existence of cointegration and causality can only be carried out once the time series properties of the data have been established. For example, tests for cointegration require the variables to be integrated to the same order, typicallyI(1), prior to estimation. By eliminating the need for unit root pre-testing, the tests applied here considerably simplify the inference procedure. They also reduce the potential for distortions in the inference due to the unknown properties of the testing sequence. Our findings include robust evidence that, for Pakistan, there is a bidirectional causality between wholesale prices and consumer prices. Feedback impact shows that influences from the wholesale price index (WPI) to the consumers' price index (CPI) is stronger or dominating as compared to feedback from CPI to WPI supporting the Cushing-McGarvey (1990) hypothesis.