Monetary pressure, inflation dynamics and structural shocks in Pakistan

Abstract

The objective of the study was to analyze whether the changes in money supply can account for variations in inflation dynamics in the presence of structural breaks by using data for the period 1970-2019. Zivot Andrews (one break) and Lee and Strazicich (two breaks) unit root tests were used to detect the structural shocks. To determine the long run relationship in the presence of structural shocks, Gregory & Hansen (1996) Cointegration test was used. Results show a robust long-run relationship between inflation, money supply, interest rate, and output. The empirical evidence show that monetary pressure has a significant role in the inflation dynamics of Pakistan, especially in the presence of structural shocks. As a policy measure, a tight monetary policy with increasing interest rates should help reduce the growth of money supply and moderate the inflation dynamics in Pakistan.