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New Keynesian Macroeconomic Model and Monetary Policy in Pakistan

Author

Listed:
  • Shahzada M. Naeem Nawaz

    (International Institute of Islamic Economics, International Islamic University, Islamabad)

  • Ather Maqsood Ahmed

    (School of Social Sciences and Humanities, National University of Sciences and Technology, Islamabad.)

Abstract

The New Keynesian (NK) models have advantage over the Real Business Cycle (RBC) models as they allow rigidities in the structure of the model, hence provide built-in mechanism to incorporate the structural shocks. The estimation of the NK model for Pakistan’s economy remains a relatively unexplored area. This study attempts to estimate a closed economy version of the NK model using robust econometric technique. On the empirical side macroeconomic dynamics have been investigated in response to unanticipated monetary shock. The reaction of the monetary authority (the State Bank of Pakistan) in response to structural shocks has been assessed by exploring the role of forward looking expectations. The SVAR model has been employed to estimate the structural parameters. The response of macroeconomic aggregates to structural shocks has also been simulated along with discussing the forecast error variance decomposition. The role of forward looking expectations is found to play prominent role in the prevailing market structure of the country. The State Bank of Pakistan (SBP) has been found to respond to shocks after a lag of one or more periods indicating time inconsistency problem which is due to discretionary monetary policy stance being adopted by the monetary authority. The distorted beliefs of economic agents about the stance of monetary policy have pointed towards weak effectiveness of the monetary policy. The results suggest that the SBP would have to adopt an independent and transparent monetary policy by following some sort of Taylor-type rule.

Suggested Citation

  • Shahzada M. Naeem Nawaz & Ather Maqsood Ahmed, 2015. "New Keynesian Macroeconomic Model and Monetary Policy in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 54(1), pages 55-71.
    • Handle: RePEc:pid:journl:v:54:y:2015:i:1:p:55-71
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    References listed on IDEAS

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    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies

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