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Role of Demand and Supply Shocks in Driving Inflation: A Case Study of Pakistan

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  • Khan, Mahmood ul Hassan
  • Hanif, Muhammad Nadim

Abstract

This study attempts to measure the relative significance of structural shocks in explaining inflation. We use monthly time series data on key macroeconomic variables of Pakistan from July 1992 to June 2011, and structural vector auto-regressions (SVAR) to understand the role of supply and demand shocks as key drivers of inflation. Long-run restrictions according to standard aggregate demand and aggregate supply framework are employed to identify structural shocks in the system. The results indicate that inflation follows a sluggish time path in response to supply shock as compared to demand shock of nominal nature. Specifically, around 75 percent of long-run impact of supply shock on inflation is realized over a period of one year horizon as compared with 90 percent for demand shock. In terms of relative significance, supply side disturbances explain 48 percent of variation in inflation over the estimation period. Within demand side, nominal shocks are relatively more important than the real demand shock. The share of real demand shock was around 10 percent, while the reaming 42 percent was attributed to nominal shock. These results suggest that in addition to monetary factors, supply side disturbances should be taken into account for better understanding of and ‘handle’ on inflation in Pakistan.

Suggested Citation

  • Khan, Mahmood ul Hassan & Hanif, Muhammad Nadim, 2012. "Role of Demand and Supply Shocks in Driving Inflation: A Case Study of Pakistan," MPRA Paper 48884, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:48884
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    References listed on IDEAS

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    Cited by:

    1. Shahzad Ahmad & Farooq Pasha, 2015. "A Pragmatic Model for Monetary Policy Analysis I: The Case of Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 11, pages 1-42.
    2. Jackson, Emerson Abraham & Kamara, Purity & Kamara, Abdulsalam, 2022. "Determinants of Inflation in Sierra Leone," MPRA Paper 117278, University Library of Munich, Germany, revised Apr 2023.
    3. Muhammad Nadim Hanif & Muhammad Jahanzeb Malik, 2015. "Evaluating the Performance of Inflation Forecasting Models of Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 11, pages 43-78.
    4. Abdullah, Muhammad & Gul, Zarro & Waseem, Faiza & Islam, Tanweer, 2021. "The State of Pakistan’s Economy and the Ineffectiveness of Monetary Policy," MPRA Paper 112678, University Library of Munich, Germany.
    5. Hanif, Muhammad Nadim, 2012. "A Note on Food Inflation in Pakistan," MPRA Paper 45009, University Library of Munich, Germany, revised 11 Mar 2013.

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    More about this item

    Keywords

    Supply Shock; Demand Shock; SVAR; Long run restrictions; Inflation;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation

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