Abstract:
This study examines the impact of monetary variables on the
balance of payments of Pakistan. Besides, exogoneity of monetary variables
is also tested. The empirical findings of the study show that balance of
payments is a monetary phenomenon and monetary policy could be useful
in improving the foreign sector. The studies so far have not confirmed this
effect. The study also shows that an increase in price level and real income
lead foreign reserves to inflow. However, an increase in the interest rate,
money multiplier and domestic credit lead international reserves to
outflow. Partial sterilisation was evident in the short run. But in the long
run, it tends to be equal to minus one, indicating no sterilisation effect on
the foreign reserve movements. The central implication derived from the
study is that an increasing government budget deficit leads to excessive
expansion in domestic credit creation and as a result a loss of foreign
reserves. The null hypothesis for exogoneity of price level, real income,
interest rate and inflation rate to foreign reserves is accepted. However,
the null hypothesis for the exogoneity of domestic credit is rejected for the
general model but accepted for the linear model. It appears that monetary
policy is effective in Pakistan.
