Do Food and Non-Food Price Volatility Granger Causes Inflation Volatility in Sri Lanka ?

Abstract

Price volatility has become a growing concern in Sri Lanka due to its direct impact on inflation and household welfare. In particular, fluctuations in food and non-food prices, along with exchange rate instability, have contributed to persistent inflationary pressures in recent years. This study examines the dynamic causal relationship between food and nonfood price volatility, and inflation volatility in Sri Lanka, using monthly data from January 2014 to April 2025. Data on the National Consumer Price Index (NCPI), Food NCPI, Nonfood NCPI, and Exchange Rate were collected from the Department of Census and Statistics (DCS) and the Central Bank report. All the variables were transformed into volatility series. The stationarity of the data series was tested using both the Augmented Dickey-Fuller (ADF) test and the Kwiatkowski Phillips Schmidt Shin (KPSS) test, confirming that all variables are stationary at level [I(0)]. The confidence ellipse curve illustrates a strong positive relationship between food volatility, non-food volatility, and inflation volatility. The results indicate that food price volatility is more closely associated with inflation volatility than nonfood price volatility. Additionally, the results of the Granger causality test show there is a bidirectional causal relationship between food volatility and inflation volatility, while no significant causality is observed between non-food volatility and inflation volatility. The findings suggest that policymakers should priorities food price stabilization through agricultural reform when designing effective monetary and inflation targeting policies.