Economic Growth, Inflation, and Monetary Policy in Pakistan: Preliminary Empirical Estimates

The recent increase in financial market volatility and the increased surge within developing world to become part of the global market have posed several challenges for policy-makers in the emerging markets to decide on a policy regime— monetary or exchange rate—that suits their needs and could also provide stability to the financial system. In view of the macroeconomic characteristics of these emerging economies, the choice of an appropriate policy becomes important to achieve certain targets such as sizeable domestic and foreign investment, reduced reliance on external borrowings, fiscal discipline, etc. These would require both price and exchange rate stability and country’s ability to deal with external shocks to maintain and achieve sustainable economic growth. Pakistan is no different and until recently had a history of macroeconomic imbalances with extremely high foreign (as well as domestic) debt, high budget and current account deficits, extremely low international reserves, high inflation, high nominal interest rates and low economic growth. The average economic growth over 40 years is around 4 percent. The main focus of any policy has been to achieve a sustainable growth pattern. However, due to a number of macroeconomic imbalances such as high budget deficits, extremely high indebtedness, low savings and investment rates, lack of fiscal discipline, undeveloped financial markets, unstable exchange rates along with high population growth and huge defence expenditure made this task almost impossible. Some of these macroeconomic imbalances contributed to episodes of high inflation and unemployment that the country experienced during most of the period since independence.