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Money, Inflation & Growth in Pakistan

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Money, Inflation & Growth in Pakistan
The Pakistan Development Review 45 : 2 (Summer 2006) pp. 203–212

Money, Inflation, and Growth in Pakistan
ABDUL QAYYUM*
This paper attempts to investigate the linkage between the excess money supply growth and inflation in Pakistan and to test the validity of the monetarist stance that inflation is a monetary phenomenon. The results from the correlation analysis indicate that there is a positive association between money growth and inflation. The money supply growth at first-round affects real GDP growth and at the second round it affects inflation in Pakistan. The important finding from the analysis is that the excess money supply growth has been an important contributor to the rise in inflation in Pakistan during the study period, thus supporting the monetarist proposition that inflation in Pakistan is a monetary phenomenon. This may be due to the loose monetary policy adopted by the State Bank of Pakistan to show the high priority of the growth objective. The important policy implication is that inflation in Pakistan can be cured by a sufficiently tight monetary policy. The formulation of monetary policy must consider development in the real and financial sector and treat these sectors as constraints on the policy.

JEL classification: E31, C22, C32 Keywords: Money Supply, Inflation, Growth, Quantity Theory, Monetary Policy, Pakistan 1. INTRODUCTION Inflation adversely affects the overall growth, the financial sector development and the vulnerable poor segment of the population. There is clear consensus that even moderate levels of inflation damage real growth [Cecchetti (2000)]. Inflation decreases the real income and also induces uncertainty. Considering such adverse impacts of inflation on the economy, there is a consensus among the worlds’ leading central banks that the price stability is the prime objective of monetary policy [King (1999); Blejer, et al. (2000)] and the central banks are committed to the low inflation [Goodfriend (2000)]. Hence the


References: Allsopp, C., and D. Vines (2000) The Assessment: Macroeconomic Policy. Oxford Review of Economic Policy 16:4, 1–32. Bilquees, F. (1988) Inflation in Pakistan: Empirical Evidence on the Monetarist and Structuralist Hypotheses. The Pakistan Development Review 27:2, 109–130. Blejer, M. I., A. Ize, A. M. Leone, and S. Werlang (2000) Inflation Targeting in Practice: Strategic and Operational Issues and Application to Emerging Economies. International Monetary Fund. Bordo, M. D., and L. Jonung (1990) The Long Run Behavior of Velocity: The Institutional Approach. Journal of Policy Modeling 12:2, 165–197. Cecchetti, S. G. (2000) Making Monetary Policy: Objectives and Rules. Oxford Review of Economic Policy 16:4, 43–59. Dwyer, G. P., and R. W. Hafer (1999) Are Money Growth and Inflation Still Related? Federal Reserve Bank of Atlanta Economic Review Second October, 32–43. Friedman, M. (1963) Inflation: Causes and Consequences. New York: Asia Publishing House. Friedman, M., and A. J. Schwartz (1982) Monetary Trends in the United States and the United Kingdom: their Relation to Income, Prices, and Interest Rates, 1867-1975. The University of Chicago Press. Goodfriend, M. (2000) Maintaining Low Inflation: Rationale and Reality. In Blejer, et al. (eds.) Inflation Targeting in Practice: Strategic and Operational Issues and Application to Emerging Economies. International Monetary Fund. Gordon, R. J. (1985) The Conduct of Domestic Monetary Policy. In Endo, et al. (eds.) Monetary Policy in Our Times. London: The MIT Press. Hasan, A. M., A. H. Khan, H. A. Pasha, and A. Rasheed (1995) What Explains the Current High Rate of Inflation in Pakistan. The Pakistan Development Review 34:4, 927–947. Hodrick, R. J., and E. C. Prescort (1997) Post-war US Business Cycles: An Empirical Investigation. Journal of Money, Credit and Banking 29, 1–16. Hossain, A. (1986) Monetary Disequilibrium and Inflation: a monetary Model of Inflation in Pakistan. The Pakistan Development Review 25:2, 141–162. 211 212 Abdul Qayyum Hossain, A. (1990) Monetarist and the Neo-Keynesian View on the Acceleration of Inflation: Some Evidence from South Asian Countries. The Pakistan Development Review 29:1, 19–32. Khan, A. H., and M. A. Qasim (1996) Inflation in Pakistan Revisited. The Pakistan Development Review 35:4, 747–759. Khan, M. S., and A. Schimmepfennig (2006) Inflation in Pakistan: Money or Wheat? (IMF Working Paper, wp/06/60.) King, M. (1999) Challenges for Monetary Policy: New and Old, in New Challenges for Monetary Policy. Proceedings of the Symposium sponsored by the Federal Reserve Bank of Kansas City. Laidler, D. (1997) Money and Macroeconomics; the Selected Essays of David Laidler. UK: Edward Elgar. Lucus, R. E., Jr. (1980) Two Illustrations of the Quantity Theory of Money. American Economic Review 70:5. McCandless, G. T Jr., and W. E. Weber (1995) Some Monetary Facts. Federal Reserve Bank of Minneapolis Quarterly Review 19:3. McCulloch, J. H. (1975) Money and Inflation: A Monetarist Approach. New York: Academic Press. Naqvi, S. N. H., A. H. Khan, A. M. Ahmed, and R. Siddiqui (1994) Inflation in Pakistan: Causes and Remedies. Pakistan Institute of Development Economics, Islamabad. Pesaran, M. H., and B. Pesaran (1997) Working with Microfit 4.0: An Interactive Approach. Oxford: Oxford University Press. Pesaran, M. H., and Y. Shin (1995) Long-run Structural Modelling. Department of Applied Economics, University of Cambridge, Cambridge. (DAE Working Paper No. 9419). Pesaran, M. H., Shin, Y., and R. J. Smith (2001) Bounds Testing Approaches to the Analysis of Level Relationships. Journal of Applied Econometrics 16, 289–326. Qayyum, A., and F. Bilquees (2005) P-Star Model: A Leading Indicator of Inflation for Pakistan. The Pakistan Development Review 44:2, 117–129. Rolnick, A. J., and W. E. Weber (1994) Inflation, Money, and Output Under Alternative Monetary Standards. Federal Reserve Bank of Minneapolis. (Research Department Staff Report 175). State Bank of Pakistan (2006) Monetary Policy Statement. Karachi: State Bank of Pakistan.
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