Inflation in Pakistan

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The Pakistan Development Review 45 : 2 (Summer 2006) pp. 185–202

Inflation in Pakistan
This paper examines the factors that explain and help forecast inflation in Pakistan. A simple inflation model is specified that includes standard monetary variables (money supply, credit to the private sector), an activity variable, the interest and the exchange rates, as well as the wheat support price as a supply-side factor. The model is estimated for the period January 1998 to June 2005 on a monthly basis. The results indicate that monetary factors have played a dominant role in recent inflation, affecting inflation with a lag of about one year. Private sector credit growth and broad money growth are also good leading indicators of inflation which can be used to forecast future inflation developments.

JEL classification: E31, C22, C32 Keywords: Inflation, Pakistan, Leading Indicators, Forecasting, Monetary Policy I. INTRODUCTION After remaining relatively low for quite a long time, the inflation rate accelerated in Pakistan starting in late 2003. Following the 1998-99 crisis, inflation was reduced to below 5 percent by 2000 and remained stable through 2003. Tight monetary policy combined with fiscal consolidation appears to have contributed to this low-inflation environment.1 Figure 1 shows that inflation follows broad money growth and private sector credit growth closely with a lag of about 12 months. With monetary growth picking up, inflation followed and increased sharply in late 2003, peaking at 11 percent year-on-year in April 2005. Average annual inflation stabilised around 8 to 9 percent by September 2005, and has receded somewhat since then. Controlling inflation is a high priority for policy-makers. High and persistent inflation is a regressive tax and adversely impacts the poor and economic development. The poor have little options to protect themselves against inflation. They hold few real assets or equity, and their savings are typically in the...
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