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Measuring the effects of monetary policy in Pakistan: a factor-augmented vector autoregressive approach

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Abstract

This paper examines the effects of monetary policy on macroeconomic variables in Pakistan’s economy using a data-rich environment. We used the factor-augmented vector autoregressive (FAVAR) methodology, which contains 115 monthly variables for the period 1992:01 to 2010:12. We compared the results of VAR and FAVAR model and the results showed that FAVAR model explains the effects of monetary policy which are consistent with the theory and better than the VAR model. VAR model shows the existence of price puzzle and liquidity puzzle in Pakistan while FAVAR model did not provide any evidence of puzzles. Interest rate negatively influences prices, hence interest rate is a good instrument for controlling inflation in Pakistan but it takes a lag of 5 months. The transmission of monetary policy shock is faster in case of prices as compared to output in Pakistan. FAVAR model supports the effectiveness of interest rate channel in Pakistan.

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Notes

  1. SBP (2002) Pakistan: Financial Sector Assessment 1990–2000.

  2. SBP (2002) Pakistan: Financial Sector Assessment 1990–2000.

  3. See Hamilton (1994) and Lutkepohl (2005) for estimation of VAR model.

  4. Discount rate is the officially announced instrument of monetary policy in Pakistan. Even though there is not much variation in it, but at monthly frequency it has sufficient variation to capture the dynamics of the monetary policy in Pakistan.

  5. The Cholesky Decomposition implies short run restrictions on the error term of the VAR model. It is a standard assumption in monetary policy analysis which enables transformation of the errors of the reduced form of the VAR model into structural innovations. This procedure is well explained in Bagliano and Favero (1998) and Christiano et al. (1999).

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Authors and Affiliations

  1. Pakistan Institute of Development Economics, Islamabad, Pakistan

    Kashif Munir & Abdul Qayyum

Authors
  1. Kashif Munir
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  2. Abdul Qayyum
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Correspondence to Kashif Munir.

Additional information

This paper is from the PhD Dissertation submitted at the Pakistan Institute of Development Economics, Islamabad, Pakistan (2012).

Appendix

Appendix

The data listed in Table 2 describe the complete description of the variable, define whether it considered slow or fast moving variables, and the transformation applied to the series to make it stationary.

Table 2 Description of the data
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Munir, K., Qayyum, A. Measuring the effects of monetary policy in Pakistan: a factor-augmented vector autoregressive approach. Empir Econ 46, 843–864 (2014). https://doi.org/10.1007/s00181-013-0702-9

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