Transmission Mechanism of Monetary Policy in Pakistan

Abstract

This paper uses vector autoregressions to examine the monetary transmission mechanism in Pakistan. The results indicate that monetary tightening leads first to a fall in domestic demand, primarily investment demand financed by bank lending, which translates into a gradual reduction in price pressures that eventually reduces the overall price level with a significant lag. In addition to the traditional interest rate channel, the results point to a transmission mechanism in which banks play an important role. We have also found an active asset price channel. The exchange rate channel has been less significant by comparison.