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On the Response of Economic Aggregates to Monetary Policy Shocks

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  • Zainab Jehan
  • Abdul Rashid

Abstract

This study empirically investigates how shocks to monetary policy measures (short-term nominal interest rate and broad money supply) affect economic aggregates: output growth, price levels and nominal exchange rate. The study is carried out for Pakistan using quarterly data covering the period from 1980 to 2009. In doing this, Johansen’s (1988) co integration technique and vector error correction model are applied to explore the long-run relationship among the variables. We find significant evidence on the existence of a long-run stable relationship between our monetary measures and economic aggregates. The impulse response functions (IRFs) are computed to examine the response of each macroeconomic variable to a standard deviation shock to monetary measures. The IRF graphs reveal a price puzzle in closed as well as in open economy model. However, an initial appreciation of exchange rate is observed, indicating the overshooting hypothesis phenomenon for Pakistan.

Suggested Citation

  • Zainab Jehan & Abdul Rashid, 2011. "On the Response of Economic Aggregates to Monetary Policy Shocks," EERI Research Paper Series EERI_RP_2011_01, Economics and Econometrics Research Institute (EERI), Brussels.
    • Handle: RePEc:eei:rpaper:eeri_rp_2011_01
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    References listed on IDEAS

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    1. Hilde C. Bjørnland, 2008. "Monetary Policy and Exchange Rate Interactions in a Small Open Economy," Scandinavian Journal of Economics, Wiley Blackwell, vol. 110(1), pages 197-221, March.
    2. Bjørnland, Hilde C., 2009. "Monetary policy and exchange rate overshooting: Dornbusch was right after all," Journal of International Economics, Elsevier, vol. 79(1), pages 64-77, September.
    3. Oliver Holtemöller, 2004. "A monetary vector error correction model of the Euro area and implications for monetary policy," Empirical Economics, Springer, vol. 29(3), pages 553-574, September.
    4. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, vol. 48(1), pages 1-48, January.
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    More about this item

    Keywords

    Monetary Policy; Economic Aggregates; VECM; Impulse Response Function.;
    All these keywords.

    JEL classification:

    • C3 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables
    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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