This paper attempts to reformulate the Cagan inflation model in order to make it more realistic and suitable for a quantitative analysis of inflation in developing countries. The most distinctive feature of the model is that it incorporates the transmission mechanism of world inflation into the domestic economy in a regime of flexible and more realistically controlled exchange rates. A short-run aggregate supply function is specified to account for the feedback of inflation on the real economy. The monetarist flavour of the Cagan model has been maintained throughout.

This modified version is tested with the annual time series data for eight developing ESCAP countries. It works relatively well for Bangladesh, Pakistan, India and Malaysia. But it performs badly for Sri Lanka, Thailand, Korea and Philippines. The major findings of the study are: the nominal money growth variable does not have a significant impact on the rate of inflation in most of the countries, whereas the real cash balances have a lagged effect on it. World inflation is one of the major determinants and the transmission of it is not only quick but more than proportionate in most of the countries. These effects are further accelerated because of their repeated devaluations. However, the increase of real income has a dampening effect on the rate of inflation in most of the countries.