Gold as an Inflation Hedge in the Indian Economy: An Empirical Investigation Using Vector Error Correction Models (VECM)

Abstract

This paper investigates whether gold functions as an effective hedge against inflation in the Indian economy over the period 1991–2023, a timeframe encompassing substantial monetary upheaval, structural reform, and recurring inflationary episodes. Using monthly data on domestic gold prices and the Consumer Price Index (CPI), we apply the Johansen cointegration framework and estimate a Vector Error Correction Model (VECM) to determine whether a stable long-run equilibrium relationship exists between the two variables. Augmented Dickey-Fuller (ADF) and Phillips-Perron (PP) unit root tests confirm that both series are integrated of order one — I (1) — satisfying the necessary precondition for cointegration analysis. Results reveal at least one cointegrating vector, consistent with the hypothesis that gold and the price level share a common stochastic trend over the long run. However, short-run dynamics tell a more complicated story: the adjustment coefficients suggest considerable deviations from equilibrium can persist for several months, and gold's hedging effectiveness varies noticeably across sub-periods. These findings carry practical implications for retail investors, institutional portfolio managers, and policymakers navigating India's inflation landscape.

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