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How External Shocks and Exchange Rate Depreciations Affect Pakistan? Implications for Choice of an Exchange Rate Regime

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  • Ahmed, Shaghil
  • Ara, Iffat
  • Hyder, Kalim

Abstract

A structural vector autoregression (VAR) model shows that external shocks are important in driving economic fluctuations in Pakistan and their importance has increased since September 11, 2001. The primary source of external shocks is foreign remittances, while foreign output has a limited effect. Keeping fixed external factors, an exogenous real exchange rate depreciation shock lowers output—a positive effect on real net exports (largely resulting from import compression rather export expansion)—is more than offset by a decline in domestic demand. The absence of common shocks with major trading partners, the importance of remittances, conventional expansionary effects on the trade balance following a real currency depreciation, and only limited evidence that credibility of anti-inflationary policy would improve with a currency peg support greater exchange rate flexibility. However, the rather large contractionary effects of real exchange rate depreciation on domestic demand suggest that greater exchange rate flexibility could destabilize aggregate output.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 16247.

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Date of creation: 15 Nov 2005
Date of revision: Jan 2006
Publication status: Published in SBP-Research Bulletin 1.2(2006): pp. 61-88
Handle: RePEc:pra:mprapa:16247

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Keywords: External Shocks; Depreciation; SVAR; Pakistan; Exchange rate;

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References

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  1. Carmen M. Reinhart & Kenneth S. Rogoff, 2002. "The Modern History of Exchange Rate Arrangements: A Reinterpretation," NBER Working Papers 8963, National Bureau of Economic Research, Inc.
  2. Shaghil Ahmed & Christopher J. Gust & Steven B. Kamin & Jonathan Huntley, 2002. "Are depreciations as contractionary as devaluations? A comparison of selected emerging and industrial economies," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 737, Board of Governors of the Federal Reserve System (U.S.).
  3. Jeffrey A. Frankel, 1999. "No Single Currency Regime is Right for All Countries or At All Times," NBER Working Papers 7338, National Bureau of Economic Research, Inc.
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  7. Ahmed, Shaghil, 2003. "Sources of economic fluctuations in Latin America and implications for choice of exchange rate regimes," Journal of Development Economics, Elsevier, Elsevier, vol. 72(1), pages 181-202, October.
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  15. John Williamson, 1996. "Crawling Band as an Exchange Rate Regime: Lessons from Chile, Colombia and Israel, The," Peterson Institute Press: All Books, Peterson Institute for International Economics, Peterson Institute for International Economics, number 14, July.
  16. Hausmann, Ricardo & Panizza, Ugo & Stein, Ernesto, 2001. "Why do countries float the way they float?," Journal of Development Economics, Elsevier, Elsevier, vol. 66(2), pages 387-414, December.
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Cited by:
  1. Adnan Haider & Musleh ud Din & Ejaz Ghani, 2012. "Monetary Policy, Informality and Business Cycle Fluctuations in a Developing Economy Vulnerable to External Shocks," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 51(4), pages 609-682.

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