Adverse Supply Shocks and the Financial Response: An Empirical Study

The present paperhas examined the role of monetary policy in mitigating the adverse supply shocks(i.e. rise in oil prices). A typical monetary policy is regarded as the stabilizing policy and it is responsible to safeguard an economy in the emergence of any negative shock from the external world. Pakistan's economy has been vulnerable to oil price fluctuations and it has often faced the long run negative impact, for instance the negative effects of 2008 commodity crises which were mainly because of the abrupt rise in oil prices. The monetary policy of Pakistan usually follows the tight policy stance as a response to such adverse supply shocks but the question always remain, how effective is it in mitigating those negative effects? In this regard, the present study has explored the effectiveness of monetary policy stance in Pakistan. In order to achieve the underlineobjective, this study has used the Shutdown Methodology in Structural Vector Autoregressive (SVAR) models on the quarterly data from 1992 to 2016. The results from the underline model have revealedthat the monetary policy of Pakistan has a limited effectiveness on its main target variables of economic output and general price level.It is advisable to monetary authority to monitor the fluctuations of international oil prices and should engage with other transmission channels of monetary policy.