Inflation and Remittances: A Causal Enigma in Developing Countries

The enigmatic link between inflation and remittances in Pakistan has puzzled economists. We argue hidden time scales, beyond short-run and long-run, hold the key. Using wavelet decomposition and employing Granger causality on 1991(07)-2022(06) data, we find a nuanced picture. Remittances from Gulf Cooperation Council (GCC) countries engage in a “bidirectional tango” with inflation in the
medium-long run
, impacting each other. Intriguingly, remittances from other regions (USA, U.K., and EU) follow similar steps, except in the USA where inflation leads remittances in the medium-long term. This partially supports our hypothesis that inflation can drive remittances, particularly during the year’s first months. While in
short run
, a counterintuitive dynamic emerges where inflation exerts a transitory influence on remittances, the relationship undergoes a reversal across the year, with remittances becoming a catalyst for inflation, potentially mediated by an upsurge in construction activity. Furthermore, our analysis indicates that remittances are predominantly utilized for essential necessities or investments, rather than nonfood purchases. Overall, in the
short
and
medium term
, inflation acts as a driver of remittances, with
cyclical fluctuations
in inflation mirroring those in remittances, particularly during the first half of the year. This dynamic weakens or disappears in the
long run
, suggesting other factors dominate. The complex relationship between inflation and remittances unfolds across
timeframes
and depends on remittance
source country
and
inflation indicator
. This study paves the way for research informing policy decisions that promote economic growth, maintain stability, and harness the full potential of remittances for Pakistan.