What determines the gold inflation relation in the long-run?. Issue 4 (2nd October 2017)

• Record Type: Journal Article
• Authors: Kumar, Satish
• Is Part Of: Studies in economics and finance. Volume 34:Issue 4(2017)
• Page Start: 430
• Page End: 446
• Publication Date: 2017-10-02
• Subjects: Cointegration -- Inflation -- Gold -- Kalman filter; Economics -- Periodicals; Finance -- Periodicals; 330
• DOI: 10.1108/SEF-04-2016-0084
• Languages: English
• ISSNs: 1086-7376

Abstract

Abstract : Purpose: The author aims to examine the long-run dynamic relation between gold price and inflation in the Indian context from 1982 to 2015. The author measures inflation using consumer price index and wholesale price index (WPI). However, this study focuses on the long-run dynamic relation between gold price–WPI inflation. Design/methodology/approach: The author uses Johansen's cointegration technique (Johansen, 1991 ); single equation error correction model based onPesaran et al . (2001 ) andKanioura and Turner (2005 ); and theSaikkonen and Lütkepohl (2000 ) approach. The author also uses a time-varying regression framework in level form based on Kalman filter to examine the dynamic nature of gold–WPI relation. Findings: The author finds no evidence of cointegration between gold and WPI. However, The author reports a significant dynamic relation between gold and inflation using a Kalman filter framework, and the comovement between these variables has in fact increased in the past decade. The results further indicate that variation in gold's sensitivity to inflation can be explained by real effective exchange rate which supports the notion of using gold as an alternative to paper currency. Moreover, the WPI beta of gold is found to be predicted by both short- and long-term interest rate changes highlighting the monetary value of gold as a valuable asset. Practical implications: From an emerging economy point of view, the results have implications for policy makers, particularly the central banks. The results of this paper caution the Reserve Bank of India against increasing its gold holdings as a reserve asset presuming that gold would preserve its purchasing power parity, at the same time providing a hedge against inflation. Originality/value: To the best of the author's knowledge, this is the first study to examine the gold price–inflation relation in the Indian market for such a long period of time. More importantly, the study shows that the changes in gold's long-term sensitivity to WPI can be forecast using fundamental variables like interest rates.