Modelling and Forecasting Inflation Rates in Sri Lanka

Sri Lanka faces a macroeconomic problem of inflation for a long period of time. The problem in somehow slows the economic growth in this country. As we all know, inflation is one of the major economic challenges facing most countries in the world especially those in South Asian countries including Sri Lanka. Therefore, forecasting inflation rates in Sri Lanka becomes very important for its government to design economic strategies or effective monetary policies to combat any unexpected high inflation in this country. This paper studies seasonal autoregressive integrated moving average model to forecast inflation rates in Sri Lanka. Using monthly inflation data from January 1988 to July 2017, after checking the stationarity of the series using ADF test the plots of ACF and PACF of first differenced data were observed to identify the appropriate model ARIMA (1, 1, 2) (2, 0, 1) 12. But based on the minimum AIC and BIC values and the significant of the model parameters the chosen model was reduced to ARIMA (1, 1, 0) (0, 0, 1) 12 can represent the data behaviour of inflation rate in Sri Lanka well which fits the monthly inflation data well as it satisfied all the assumptions of model adequacy. Based on the selected model, we forecast eight (8) months inflation rates of Sri Lanka outside the sample period (i. e. from August 2017 to March 2018). The observed inflation rate of August and September which was published by Sri Lanka Statistical Service Department fall within the 95 % confidence interval obtained from the designed model. The forecasted results show a decreasing pattern and in the subsequent months, the pattern shows an increasing and decreasing pattern one thing away.