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How External Shocks and Exchange Rate Depreciations Affect Pakistan? Implications for Choice of an Exchange Rate Regime

Shaghil Ahmed, Iffat Ara and Kalim Hyder
Authors registered in the RePEc Author Service: Syed Kalim Hyder Bukhari ()

MPRA Paper from University Library of Munich, Germany

Abstract: A structural vector autoregression (VAR) model shows that external shocks are important in driving economic fluctuations in Pakistan and their importance has increased since September 11, 2001. The primary source of external shocks is foreign remittances, while foreign output has a limited effect. Keeping fixed external factors, an exogenous real exchange rate depreciation shock lowers output—a positive effect on real net exports (largely resulting from import compression rather export expansion)—is more than offset by a decline in domestic demand. The absence of common shocks with major trading partners, the importance of remittances, conventional expansionary effects on the trade balance following a real currency depreciation, and only limited evidence that credibility of anti-inflationary policy would improve with a currency peg support greater exchange rate flexibility. However, the rather large contractionary effects of real exchange rate depreciation on domestic demand suggest that greater exchange rate flexibility could destabilize aggregate output.

Keywords: External Shocks; Depreciation; SVAR; Pakistan; Exchange rate (search for similar items in EconPapers)
JEL-codes: E3 (search for similar items in EconPapers)
Date: 2005-11-15, Revised 2006-01
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Published in SBP-Research Bulletin 1.2(2006): pp. 61-88

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