Investigating the root of inflation in Sri Lanka–Money supply or exchange rate?

This work was the basis of my master thesis, which can be downloaded here. GitHub repository here.

Is inflation, as Milton Friedman believed, 'always and everywhere a monetary phenomenon'? Not everyone agrees. For post-Keynesian economists, inflation is the result of conflict between workers and firms as they constantly try to increase wages and prices, respectively, leading to a spiral. In an open economy, this wage–price spiral can be exacerbated by external shocks to the currency exchange rate. As Sri Lanka recovers from the financial crisis of 2022 when crippling inflation reached record levels of 70% year-over-year, the public discourse remains dominated by the monetarist view that blames government deficit spending for the rise in prices. However, the Sri Lankan rupee suffered sharp devaluations immediately before the inflationary upsurge, making the post-Keynesian explanation a plausible alternative hypothesis.

This ongoing project aims to find the root causes of inflation in Sri Lanka by evaluating these two theories using macroeconomic and financial data and secondary sources. For this, I propose two models based on the two theories through a political economy perspective and then evaluate the models through time-series analysis. I aim to provide a pluralist understanding of inflationary processes and contribute to democratic debate on monetary policy. Further, I hope to increase our understanding of the little-studied Sri Lankan economy.