Underlying Factors of Inflation in Pakistan:Dynamic Effects and Contributions

This paper attempts to estimate the impact of underlying factors of inflation and their contribution to inflation overtime. Using structural VAR on monthly data from June 2002 to June 2024, we first estimate the pass through effects of the main drivers of inflation and then decompose the historical movements in inflation into identified structural shocks. The findings show that pass-through of commodity prices and inflation expectations shocks to inflation is relatively quick but larger in case of exchange rate and money supply, whereas it is gradual and smaller for fiscal policy shock. The historical decomposition shows that shocks to inflation are majorly explained by global commodity prices, money supply and fiscal stance. The impact of exchange rate and uncertainty have been significant, though irregular, at times. The role of inflation expectations has also become prominent in recent years, explaining significant part of post-COVID surge in inflation. Contribution of other factors, including input costs and floods has been relatively lower. The results underscore the importance of fiscal prudence to complement the monetary policy stance to successfully achieve and maintain price stability. The findings also point to appropriately anchor inflation expectations.