Foreign Inflows and Existence of Dutch Disease: Empirical Evidence from Pakistan

Abstract

This paper tries to evaluate the economic importance of foreign inflows in determining the real effective exchange rate. Monetary policy plays a substantial role in determining the stability of prices, trade and foreign inflows like foreign direct investment, personal remittances, and foreign aid. In this study, the causal relationship is analyzed among policy variables and control variables. The study used secondary time series data from 1960-to 2020. Augmented Dickey Fuller (ADF) and Philips Perron (PP) unit root tests are used to check the stationary of the variables. Results showed that all variables are stationary at the level I (0) and the first difference I (1). The auto regressive distributive lag (ARDL) approach and Granger Causality approach is discussed to find cointegration and causality respectively. ARDL Bound test reveals the cointegration existence among the variables. ARDL results suggest that foreign inflows (Foreign Direct Investment, Foreign Aid, Personal Remittances), Trade and Inflation showed a significant relationship with Real Effective Exchange Rate in the long run. Granger Causality suggested the existence of Causality among Foreign Aid and Real Effective Exchange Rate, Foreign Direct Investment and Foreign Aid, Trade and Remittances. The results of the study are found in contradiction with the law of one price.