Monetary Policy, Price Stability and Financial Stability – The Nexus for Pakistan

Jameel Ahmed

MPRA Paper from University Library of Munich, Germany

Abstract: This chapter explores the interactions of monetary policy, price stability and financial stability for a developing country. A new, parsimonious index of financial instability is introduced and the dates of financial stress in Pakistan are documented. The dynamic interactions are investigated via impulse responses (IRs) using the local projection. Building on an augmented Taylor rule, we segregate the IRs across business cycle. We find that the monetary policy (MP) shocks generate asymmetric responses: more effective during recessions than expansions. The impulses in MP dampen inflation and output during recessions while the financial stress increases, calling for a cautious policy approach to avoid trade-offs between twin objectives of price and financial stability. The MP tightens and the output falls in the event of a financial instability shock with no significant impact on inflation. The trade-off between two objectives during downturns is also manifest here. Finally, MP responds forcefully to inflationary shocks during expansions, but at the cost of worsening financial conditions.

Keywords: Financial Stress Index; Financial Stability Index; Price Stability (search for similar items in EconPapers)
JEL-codes: E31 E52 G01 G17 (search for similar items in EconPapers)
Date: 2023-09
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Published in Governance and Policy Transformation in Central Banking (2024): pp. 27-43

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