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Effectiveness of monetary policy: Application of modified Peter and Clark (PC) algorithms under Graph-Theoretic Approach

Author

Listed:
  • Rizwan Fazal

    (None)

  • Md. Shabbir Alam

    (None)

  • Umar Hayat

    (None)

  • Naushad Alam

    (None)

Abstract

It is common practice that central banks around the world must adopt an inflation targeting framework; based on the assumption that inflation could be reduced by increasing interest rates. On contrary, the theoretical literature and data-based evidences differ remarkably. The arduous attached in finding the true association and causation is the existence of multiple monetary transmission channels. Theoretical literature lists both monetary and non-monetary channels linking interest rate and inflation. However, most of the existing studies are focused on single equation model ignoring other parallel channels. This study is first of its kind where we have developed modified Peter and Clark (PC) algorithm of the Graph-Theoretic approach taking all the monetary and non-monetary channels to determine the causal nexus between monetary policy and inflation. The results show that, causality is running from interest rate towards inflation; suggesting a positive and significant long run relationship of interest rate with inflation in case of Pakistan. Furthermore, monetary policy have cost-side effects on inflation; however, the monetary policy becomes counterproductive whenever high interest rate is used to decrease cost push inflation. Therefore, there is need of serious rethinking about current monetary policy regime. JEL Codes - E4; E5; E42; E52

Suggested Citation

  • Rizwan Fazal & Md. Shabbir Alam & Umar Hayat & Naushad Alam, 2021. "Effectiveness of monetary policy: Application of modified Peter and Clark (PC) algorithms under Graph-Theoretic Approach," Scientific Annals of Economics and Business (continues Analele Stiintifice), Alexandru Ioan Cuza University, Faculty of Economics and Business Administration, vol. 68(3), pages 333-344, September.
    • Handle: RePEc:aic:saebjn:v:68:y:2021:i:3:p:333-344:n:218
    DOI: 10.47743/saeb-2021-0019
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    More about this item

    Keywords

    monetary policy; inflation; causality; Graph theory;
    All these keywords.

    JEL classification:

    • 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
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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