Implications of Oil Price Changes for the Economy: An Aggregate Analysis for Pakistan Volume 29, Issue 1

Abstract

This study utilizes interim multipliers analysis based on a VAR-X model to investigate the impacts of changes in the world’s crude oil prices on output growth rates, inflation rates, real exchange rates, and real interest rates in Pakistan. The study finds that following oil price inflation, the output growth rate initially increases but then declines in the medium to long run. The effects of oil price deflation on output growth are the opposite, though smaller in magnitude. Oil price inflation is also found to cause a moderate increase in the overall inflation rate, while oil price deflation reduces the inflation rate by a smaller margin. The resilience of the economy to oil price changes is attributed to the low share of oil in production costs, subsidized oil prices by Middle Eastern countries, remittance inflows from workers in the Gulf States, and the managed exchange rate regime. The study recommends the continuation of a conservative monetary policy, the development of inter-provincial political consensus on major hydro projects, and the ensuring of the credibility of fiscal measures aimed at the solarization of the economy, focusing more on long-term considerations rather than short-term budgetary compulsions