THE ROLE OF EXCHANGE RATE AND MONETARY POLICY IN SHAPING PAKISTAN’S ECONOMIC GROWTH AND INFLATION

Abstract

Higher inflation or a state of a sustained general rise in prices is described by economists as inflation and is a monetary phenomenon as it can be explained clearly in terms of relationship in money supply. It is demonstrated in existing literature that there is means through which money growth continues to have a causal effect on inflation in the context of the different exchange rate regime and stability of the money supply function across various countries and periods. However, there is a trend in the literature of using monocycle as less important variable in monetary policy for maintaining price stability, particularly under IT regime. Since 1972, with the start of inflation targeting regime in Pakistan, such autonomy is as a policy which does not admit a link between money growth and inflation and with GDP. It is theoretically and in the practice of the best monetary policy for stabilizing price level that the idea that money does not matter with regard to inflation and GDP seems odd. This paper employs the data spanning the 1972-2022 fiscal year. In order to test this for Pakistan, this paper employs the auto regressive distributed lag (ARDL) counteraction technique to know whether money supply, exchange rate, domestic investment, labor force and government expenditure can or not maintain its long-run relationship with money supply. The empirical results have also supported the theoretical money supply hypothesis of the long-run relationship between the exchange rate, Government expenditure, and domestic investment exchange rate for Pakistan. The result of the error-correction model supports the long run integrates among these variables; it further supports that, money supply growth causes inflation and GDP in the short run. By building on the theoretical propositions stemming from theoretical framework and empirical premises, the paper surmise that in relation to the form of monetary policy for price stability, the monetary aggregate and its growth rate still counts in terms of inflation and GDP.