Monetary Policy Transmission Mechanism of Pakistan: Evidence from Bank Lending and Asset Price Channels

Abstract

The lending and asset price transmission channels remain largely unexplored since financial reforms and pursuance of market-based monetary policy instruments. This paper examines the monetary policy transmission mechanisms of Pakistan with a special focus on bank lending and asset price channels. Monthly data over the period 2000M7-2016M12 is being used for the short run analysis. The empirical investigation is based on SVAR framework. The results show that the monetary aggregates targeting agenda is still operative in effecting the output and general price level. Bank lending have a non-trivial part through the investment channel and share prices through wealth effect on price level and output, while the conventional interest rate channel seemed to be ineffective in the transmission mechanism process in Pakistan. The findings of generalized impulse response functions are backed by the generalized error forecast variance decomposition analysis. In addition to domestic variables, external shocks appear to have a strong influence on inflation and output in Pakistan.Contribution/ Originality: This study contributes in the existing literature by examining the monetary policy transmission mechanisms of Pakistan with a special focus on bank lending and asset price channels.

External Monetary Constraints Imposed by Developed Economies on Developing Economies: Empirical Evidence from Pakistan

“…Many researchers and economists wrote papers on the international monetary policy linkages. This monograph summarizes some of the key papers and their findings related to the monetary policy transmission mechanism, independence of monetary policy, international monetary policy coordination, external shocks linkages with monetary policy and global financial crises role in external monetary constraints (Mukhtar and Younas, 2019).…”

“…Before exploring these key ideas, we need to enlighten that there are two main types of monetary policies which includes expansionary monetary policy and contractionary monetary policy. The expansionary means increase in money supply while contractionary means a reduction in the money supply of an economy (Mukhtar and Younas, 2019). Friedman and Schwartz (1963) conducted a seminal study and established the importance of changes in monetary policy for real macro variables.…”

“…This channel is an extension of the traditional interest rate channel and emphasizes the role of banks in monetary transmission. The exchange rate channel is also a significant channel that focuses on the impacts of monetary policy shocks on the exchange rate and consequently on aggregate supply and aggregate demand (Mukhtar and Younas, 2019). Taylor (1995) asserted that the magnitude of the exchange © 2020 AESS Publications.…”

“…In simple words, these external shocks have severe impacts on the Pakistan economy but not in control of the State Bank of Pakistan or finance ministry of Pakistan. Some important external shocks that have an impact on the macro performance of a country like Pakistan includes external oil price shocks, global gold price shocks, exchange rate shocks and global food price shocks (Mukhtar and Younas, 2019). The monetary policy of an economy based on a dual mandate which is: full employment level with stabilized prices or inflation rate 1 (Surico, 2007;Rudebusch and Williams, 2016).…”

“…both inside lag and outside lag of monetary policy (Baek and Miljkovic, 2018). In the third place, the impact of monetary policy on real economy can be estimated accurately and efficiently by studying monetary transmission mechanism (Mukhtar and Younas, 2019).…”