Impact of Money Supply

Topics: Monetary policy, Inflation, Central bank Pages: 10 (3077 words) Published: November 28, 2010
European Journal of Scientific Research ISSN 1450-216X Vol.41 No.2 (2010), pp.314-322 © EuroJournals Publishing, Inc. 2010

Impact of Money Supply on Current Account: Extent of Pakistan Sulaiman D. Mohammad Department of Economics, Federal Urdu University, Karachi E-mail: Abstract The purpose of this research is to find out the empirical association among money supply, current account, exchange rate, and industrial production, for this purpose we have used (Johansen, 1988) co integration technique to analyze the long run relationship and Error Correction model to estimate the short run dynamics by using annual data for the period of 1975 to 2008. The domestic variables support long run relationship and weak relation in short run. Fragile combination of fiscal and monetary policy, finding supports Jcurve theory and expenditures switching affect theory. Keywords: Money supply, Current Account, Co-integration JEL Classification: C5, E5, F4

1. Introduction
Economic management, stabilization and adjustment of any developing country are totally concern with the main instruments of an economy, monetary policy and foreign exchange rate. In most of developing economies real exchange rate shows the international competitiveness and high inflation as a result of currency devaluation and expansionary monetary policy. Monetary policy refers to implementations of central bank or monetary authorities that focusing on supply and availability of money regarding to reduce unemployment and control inflation. Keynesian economists argue expansionary monetary policy lead to economic growth, Monetarists explain ideal condition for maintaining inflation and steady growth is constant or slow increase of money supply. There are many types of monetary policies which focus on inflation, exchange rate and money supply. Monetarists believe in money supply targeting policy. In exchange rate targeting policy authorities adopt pegged exchange rate and some time devalue local currency in case of developing countries, exchange rate targeting policies lead to increase black economy. In inflation targeting or price level targeting policies central bank adjust interest rate according to economic condition. Interest rate plays a key role towards maintaining output gap and inflation (John B. Tylor). Some European and Asian countries, as well as Pakistan is also practicing inflation targeting policies. In case of our country both policies inflation targeting and exchange rate targeting polices simultaneously practiced but these policies did not show significant impact. What were the main reasons, economists argued that there is no coordination between fiscal and monetary policies. The statistical facts of money supply for last few decades mentioned in appendix. A wide ranging empirical literature has documented deferred and constant effects of monetary policy shocks on output. Theoretically real interest rate, inflation and the industrial production are the

Impact of Money Supply on Current Account: Extent of Pakistan


result of money supply, expansionary policy leads to depreciate currency and current account deficit in short run while, contractionary monetary shock leads to current account surplus in short run (Jaewoo Lee). Many economists have examined that fluctuation in the central fund rates are a significant proxy for changes in monetary policy. Central fund rate have significant impact on macroeconomic aggregates but after 1980 it has been seen good measure of monetary policy but its impact on macroeconomic aggregates are not considerable (Nathan S. Balke & Kenneth M. Emery). (Michael B. Devereux and Hans Genberg) examined by using open macro economic model in the case of China, expansionary monetary policy leads to increase in the real output and permanent price level for the time being, some countries have been selected like Hong Kong and Philippines. It is found an...

References: Appendix
Time Deposits & M2 as % of Total Deposit & GNP (1970-2007)
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