Effectiveness of the Exchange Rate Channel in Monetary Policy Transmission in Pakistan (Article)

Fayyaz Hussain and Mehak Ejaz
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Fayyaz Hussain: Senior Joint Director, State Bank of Pakistan, Karachi.

The Pakistan Development Review, 2022, vol. 61, issue 1, 45-67

Abstract: The exchange rate is one of the most important channels of monetary policy transmission to the real economy. However, the effectiveness of this channel depends on the extent of exchange rate flexibility, degree of international capital mobility, and inflation expectations. Like other emerging economies, Pakistan is typically characterised by weak fiscal and monetary institutions, currency substitution, liability dollarisation, and vulnerability to sudden stops of capital flows. These features compel emerging economies to follow managed exchange rate regimes by restricting the mobility of capital flow. All these factors weaken the effectiveness of the exchange rate channel of monetary policy transmission. This study estimates the effectiveness of the exchange rate channel in monetary policy transmission in Pakistan and explores the impact of exchange rate regimes on the channel’s strength.

Keywords: Monetary Policy; Transmission Channels; Pakistan; Exchange Rate; Exchange Rate Regimes; Structural VARs (search for similar items in EconPapers)
JEL-codes: E52 F21 F31 (search for similar items in EconPapers)
Date: 2022
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