Please use this identifier to cite or link to this item: http://prr.hec.gov.pk/jspui/handle/123456789/2167
Title: EXCHANGE RATE FLUCTUATIONS AND ITS IMPACT ON OUTPUT GROWTH, PRICE LEVEL AND FOREIGN EXCHANGE RESERVES IN PAKISTAN (1973-2008)
Authors: TARIQ, MUHAMMAD
Keywords: Social sciences
Economics
International economics
Issue Date: 2012
Publisher: UNIVERSITY OF PESHAWAR KHYBER PAKHTUNKHWA PAKISTAN
Abstract: With the breakdown of Bretton Woods in 1970s, most of the world economies shifted from fixed to flexible exchange rate system. This new development increased the variability of exchange rate in the overall macroeconomic performance and it became the central focus of the monetary authorities in both the developed and developing countries. A stable exchange rate plays a significant role in the settlement of major macroeconomic variables like output, price level and foreign exchange reserves. Whereas, its instability hinders investment, trade flow and economic growth in an economy. It also provides additional aggregate demand and supply transmission channels which help in the implementation of suitable monetary policy. Exchange rate is determined by a number of factors, the identification of which can be useful for maintaining economic stability and solving monetary ills. Among the developing countries, Pakistan experienced a unique downward trend in rupee value and frequent transitions in the exchange rate systems. These distinctive features make Pakistan economy an interesting case study for the empirical examination of the rupee exchange rate and its role in the monetary policy and macroeconomic performance. The purpose of the present study is to find out which of the macroeconomic indicators has led the Pak-rupee Real Exchange Rate (RER) depreciations during the study period. Moreover, the role of the RER in a Taylor rule based monetary policy of the State Bank of Pakistan (SBP) has also been analyzed. Likewise, the impact of RER on output has been examined in an open economy IS curve framework for testing the contractionary hypothesis of real devaluations in Pakistan. Also, the influence of the RER on inflation has been investigated in the framework of an open economy Phillips curve approach. Furthermore, the affect of the RER on foreign exchange reserves has also been studied in the framework of a mercantilist approach. Finally, the relationship of the different exchange rate systems with the RER, monetary policy, output, price level and foreign exchange reserves have also been explored. Time series annual data covering the period 1973 to 2008 has been used for the empirical analysis. Augmented Dickey Fuller test has been used for checking the unit root in the data. Hodrick Prescott filter method has been applied for extracting the cyclical components from the observed series. Ordinary Least Squares method is used for the estimation of regression equations. The overall significance of the models has been analyzed by using Wald test. For avoiding the problems of spurious relationship between the variables and series implications for the standard errors and Durbin Watson statistic, Newy-West test has been applied. The reliability of the results has been confirmed by using the Diagnostic tools i.e. Q-statistic and LM test. CUSUM stability tests are used for checking the stability of the parameters and regression variances. Analyzing the determinants of RER, the results showed that real exchange rate fluctuations over the sample period have historically been accounted for both the domestic and foreign factors i.e. domestic inflation, domestic interest rate and US interest rate and inflation. Moreover, exchange rate regime policies are also showed to be relevant to the real exchange rate. Investigating the role of RER in the monetary policy of Pakistan, the results showed a systematic reaction to RER by the SBP in addition to the output and inflation gaps. In respect of the impact of exchange rate systems on the monetary policy, the results showed that monetary policy in Pakistan has remained constant on the different exchange rate systems followed by the SBP during the study period. Testing the contractionary hypothesis of real depreciations, it has been concluded that RER depreciations increase the output gap in Pakistan. Exchange rate regime switches are also showed to be relevant with the output gap. Dealing with the role of the RER in the determination of inflation, it is found that real depreciations is of help to describe the evolution of prices in Pakistan. It is also found that switching in exchange rate regimes explains the inflation. Finally, examining whether reserves holdings in Pakistan is motivated by precautionary or mercantilist motives, the results showed that reserves holdings in Pakistan is the by-product of the export led growth strategies of Pakistan through RER depreciations. Moreover, movement towards the floating regimes also boosted the foreign exchange reserves holdings during the study period. On the basis of the findings, it has been recommended that the SBP should also take into account foreign factors in addition to the domestic factors for the stability of RER. Also instead of targeting the monetary aggregates, the SBP should follow a rule based monetary policy where RER fluctuations should also be taken into account. Moreover, instead of devaluations of rupee for increasing exports, the government is required to follow import substitution policies. Furthermore, to increase the inflow of foreign exchange reserves in the country, the development of export sector of the country can play an important role.
URI:  http://prr.hec.gov.pk/jspui/handle/123456789//2167
Appears in Collections:PhD Thesis of All Public / Private Sector Universities / DAIs.

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