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How External Shocks and Exchange Rate Depreciations Affect Pakistan? Implications for Choice of an Exchange Rate Regime

Author

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  • Ahmed, Shaghil
  • Ara, Iffat
  • Hyder, Kalim

Abstract

A structural vector autoregression (VAR) model shows that external shocks are important in driving economic fluctuations in Pakistan and their importance has increased since September 11, 2001. The primary source of external shocks is foreign remittances, while foreign output has a limited effect. Keeping fixed external factors, an exogenous real exchange rate depreciation shock lowers output—a positive effect on real net exports (largely resulting from import compression rather export expansion)—is more than offset by a decline in domestic demand. The absence of common shocks with major trading partners, the importance of remittances, conventional expansionary effects on the trade balance following a real currency depreciation, and only limited evidence that credibility of anti-inflationary policy would improve with a currency peg support greater exchange rate flexibility. However, the rather large contractionary effects of real exchange rate depreciation on domestic demand suggest that greater exchange rate flexibility could destabilize aggregate output.

Suggested Citation

  • Ahmed, Shaghil & Ara, Iffat & Hyder, Kalim, 2005. "How External Shocks and Exchange Rate Depreciations Affect Pakistan? Implications for Choice of an Exchange Rate Regime," MPRA Paper 16247, University Library of Munich, Germany, revised Jan 2006.
  • Handle: RePEc:pra:mprapa:16247
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    References listed on IDEAS

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    Cited by:

    1. 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.

    More about this item

    Keywords

    External Shocks; Depreciation; SVAR; Pakistan; Exchange rate;

    JEL classification:

    • E3 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles

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