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A Small Open Economy DSGE Model for Pakistan

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  • Haider, Adnan
  • Khan, Safdar Ullah

Abstract

This paper estimates a small open economy Dynamic Stochastic General Equilibrium (DSGE) model for Pakistan using Bayesian simulation approach. Model setup is based on new Keynesian framework, characterized by nominal rigidity in prices with habit formation in household’s consumption. The core objective is to study whether an estimated small open economy DSGE model provides a realistic behavior about the structure Pakistan economy with fully articulated description of the monetary policy transmission mechanism vis-à-vis domestic firm’s price setting behavior. To do so, we analyze the impulse responses of key macro variables; domestic inflation, imported inflation, output, consumption, interest rate, exchange rate, term of trade to different structural/exogenous shocks. From several interesting results, few are; (a) high inflation in Pakistan do not hit domestic consumption significantly; (b) Central bank of Pakistan responds to high inflation by increasing the policy rate by 100 to 200 bps; (c) exchange rate appreciates in both the cases of high domestic and imported inflation; (d) tight monetary policy stance helps to curb domestic inflation as well as imported inflation but appreciates exchange rate significantly (f) pass through of exchange rate to domestic inflation is very low; finally parameter value of domestic price stickiness shows that around 24 percent domestic firms do not re-optimize their prices which implies averaged price contract is about two quarters.

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  • Haider, Adnan & Khan, Safdar Ullah, 2008. "A Small Open Economy DSGE Model for Pakistan," MPRA Paper 12977, University Library of Munich, Germany, revised 17 Jan 2009.
  • Handle: RePEc:pra:mprapa:12977
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    4. Ahmed, Shahzad & Pasha, Farooq, 2014. "The Role of Money in Explaining Business Cycles for a Developing Economy: The Case of Pakistan," MPRA Paper 55262, University Library of Munich, Germany, revised 11 Apr 2014.
    5. 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, vol. 51(4), pages 609-681.
    6. Shahid, Muhammad & Qayyum, Abdul & Shahid, Waseem, 2016. "Fiscal and Monetary Policy Interactions in Pakistan Using a Dynamic Stochastic General Equilibrium Framework," MPRA Paper 72595, University Library of Munich, Germany.
    7. Sara Shahraki & Ahmad Sabahi & Mohammad Hossein Mahdavi Adeli & Mostafa Salimifar, 2016. "Currency Substitution Theory, a New Chanel to Enter the Exchange Rate as the Monetary Transmission Mechanism," Economic Analysis Working Papers (2002-2010). Atlantic Review of Economics (2011-2016), Colexio de Economistas de A Coruña, Spain and Fundación Una Galicia Moderna, vol. 2, pages 1-1, December.
    8. Shahzad Ahmad & Adnan Haider, 2019. "An evaluation of the forecast performance of DSGE and VAR Models: The case of a developing country," Business Review, School of Economics and Social Sciences, IBA Karachi, vol. 14(1), pages 28-52, January-J.
    9. Carlos C. Bautista, 2009. "An examination of Philippine monetary policy rules," UP School of Economics Discussion Papers 200912, University of the Philippines School of Economics.
    10. Hassan, Rubina & Shahzad, Mirza Muhammad, 2011. "A macroeconometric framework for monetary policy evaluation: A case study of Pakistan," Economic Modelling, Elsevier, vol. 28(1-2), pages 118-137, January.
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    More about this item

    Keywords

    New-Keynesian economics; open economy DSGE models; nominal rigidities; monetary policy transmission mechanism; Bayesian Approach;
    All these keywords.

    JEL classification:

    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications
    • E47 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Forecasting and Simulation: Models and Applications

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