European Journal of Economic Studies, 2014, Vol.(9), № 3 135 Copyright © 2014 by Academic Publishing House Researcher Published in the Russian Federation European Journal of Economic Studies Has been issued since 2012. ISSN: 2304-9669 E-ISSN: 2305-6282 Vol. 9, No. 3, pp. 135-142, 2014 DOI: 10.13187/es.2014.3.135 www.ejournal2.com UDC 33 Testing Relationship between Inflation, M2 (Broad Money) and Private Sector Credit in Pakistan 1 Zeeshan Fareed 2 Muhammad Awais Baloch 3 Rab Nawaz Lodhi 4 Farrukh Shahzad 5 Bushra Zulfiqar 1 MS Scholar, COMSATS Institute of Information Technology, Sahiwal, Pakistan Email: zeeshanfareed@hotmail.com 2 PhD Scholar, University of Management and Technology, Lahore, Pakistan Email: balochmetro@yahoo.com 3 PhD Scholar, Bahria University Islamabad, Pakistan Email: rabnawazlodhi@yahoo.com 4 MS Scholar, Lahore Leads University, Lahore, Pakistan Email: farrukh.hailian@gmail.com 5 M.A Scholar, University of the Punjab, Lahore, Pakistan Email: bushra_zulfiqar786@hotmail.com Abstract. This research paper examines the impact of inflation with M2 (broad money) and private sector credit in Pakistan and helps to forecast inflation and its affect in Pakistan during the year 1975 to 2008. Inflation is defined as too much money chasing too few goods. Inflation leads to high prices and that affect all mechanism of the market. The rate of inflation is an important macroeconomic indicator that can affect the economic growth. Inflation was in lime light throughout the year, as the rise of global inflation witnessed during the most part of 2008. This paper finds out that an increase in money supply over long-run results in higher rate of inflation. Thus it establishes that inflation is essentially a monetary phenomenon. The results indicate that monetary factors have played a dominant role in recent inflation. Changes in wheat support price influence inflation in short-run, but not in long-run. Thus by using data from 1975- 1976 to 2007-2008 period, applying Augmented Dickey-Fuller tests, its finds that the most important determinants of inflation in 2007-2008 were adaptive expectations private sector credit and rising import prices whereas fiscal policy‘s contribution to inflation was nominal. Analysis of price multiplier indicates that increase in wheat procurement prices have relatively small effects on overall price levels. Keywords: Inflation; Broad Money; Credit Sector; Pakistan. Introduction. Inflation is one of the most researched topics in economics because it has serious implication for growth and income distribution. The monetarists believe that inflation is essentially a monetary phenomenon and the developing countries are no exception to that rule. The rate of inflation is an important macroeconomic indicator and one of the key variables most of