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A macroeconometric framework for monetary policy evaluation: A case study of Pakistan

  • Hassan, Rubina
  • Shahzad, Mirza Muhammad

This paper attempts to establish the quantitative importance of the various channels of monetary transmission by constructing, estimating and simulating a small macroeconometric model of Pakistan's monetary sector, while using data from the monetary statistics and the monetary survey of the State Bank of Pakistan over 1976–2007. The paper elucidates that the key feature of the study of monetary policy in Pakistan has been preoccupied with neglect either of the demand or the supply function of money and shows how this may lead to imprecise policy actions and mistaken conclusions. Accordingly, we delineate the transmission mechanism of monetary policy by taking into consideration all structural money demand and money supply linkages along with the historically implied identifying assumption in the framework of a marginalized macroeconometric model. The within-sample and out-of-sample evaluations of the model are found satisfactory. The paper presents results of three policy simulations from the estimated model that highlight the impact of alternative monetary policy instruments on the monetary variables under a rule-based and a discretionary policy environment. We find that (i) the SBP subscribes to an unannounced monetary policy rule, (ii) the determination of the policy rate under the announced rule environment stabilizes the monetary sector in that convergence to full equilibrium is smooth and rapid, (iii) a 100bps reduction in the discount rate, ceteris paribus, decreases money supply by 4.97%, and (iv) the long term implication of reducing (increasing) the reserve requirement ratio on time (demand) deposits, ceteris paribus, is only higher inflation. Finally, we establish that a 100bps increase in interest rate increases money supply by 3.14% in full equilibrium.

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Article provided by Elsevier in its journal Economic Modelling.

Volume (Year): 28 (2011)
Issue (Month): 1 ()
Pages: 118-137

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Handle: RePEc:eee:ecmode:v:28:y:2011:i:1:p:118-137
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/30411

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