When and Why does Bangladesh’s Inflation Differ from India’s?

India and Bangladesh share a common historical background, geographical proximity, institutional similarities, and a policy shift towards economic liberalization since the early 1990s. Inflation between these countries, however, often remains remarkably different, and the series of inflation differential between them does not follow any consistent pattern over time, suggesting an intriguing area of investigation. Working over the 1979- 2010 period, this study finds support in favor of the Friedman hypothesis of the primacy of money supply in determining inflation in a country after accounting for supply shocks. In an Autoregressive Distributed Lag (ADL) model, this work shows that Bangladesh experienced higher inflation than India whenever Bangladesh’s money supply grew faster than India’s. The same is true for India as well, suggesting that both central banks must maintain their restrained stance in money supply if they need to lower inflation. [Working Paper Series: WP 1301].