Measuring Monetary Policy Effects in Pakistan: An FAVAR Approach

Abstract

In this study monetary policy’s influence on the major macroeconomic indicators for Pakistan are examined by using a time series annual data for the period in between 1990 to 2020. The results of VAR model reveal that the influence of monetary policy on the macroeconomic variable in Pakistan is consistent with the explanations given in the theory. Interest rate is influencing the overall economic activity in the country and it is a good instrument to control inflation in the economy of Pakistan but it influences the economy after a period of five lags.  A surprise in monetary variable is transmitted more quickly in prices in comparison to the output. The empirical and quantitative analysis of the data of Pakistan showed that inflation is negatively influencing the rate of output growth. In the empirical analysis output, money supply, household’s consumption, inflation and interest rate have been taken and interest rate as a channel of monetary surprise transmission is analytically observed. The study of conitegration showed there are three co-intigrating equations and normalized coefficients indicated that inflation and interest rate are negatively influencing the output growth in Pakistan while household consumption, money supply and overall economic activity has positive impact. The results of Granger Causality are as per the expectations and are robust.