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Is Inflation a fiscal phenomenon in Pakistan? By Hamna Ahmed Department of Economics, University of Warwick. PowerPoint Presentation
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Is Inflation a fiscal phenomenon in Pakistan? By Hamna Ahmed Department of Economics, University of Warwick. To answer this question we will be looking at the following variables: Fiscal deficits D = G – t Seiniorage S = M – M (-1) /P Price level. Motivation.

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Is Inflation a fiscal phenomenon in Pakistan?ByHamna AhmedDepartment of Economics,University of Warwick.

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To answer this question we will be looking at the following variables:
  • Fiscal deficits

D =G – t

  • Seiniorage

S = M – M(-1)/P

  • Price level
motivation
Motivation
  • Inflation in Pakistan:

Persistent

Ever-increasing

A serious challenge

objective
Objective

A simple model has been designed to assess:

  • Direct Impact of d on p:

 d   aggregate demand  p

  • Indirect Impact of d on p:

 d  s by printing money   p

a step wise approach
A Step-wise Approach
  • Step I

A preliminary model – any meaningful long-run relationship between deficit & seiniorage?

  • Step II

The final model – all three variables tested jointly.

direct indirect impact illustrated

Fiscal Deficits

Seigniorage

Inflation

Direct & Indirect Impact illustrated

Channel 1  direct

Channel 2 to 3  indirect

1

2

3

methodology
Methodology
  • Johansen approach to co-integration analysis
  • Interested in long-run dynamics only because….
  • Data– annual time series,

Sample period: 1956 – 2005,

Source: IFS repository.

model specification
Model Specification
  • Model Specification – log-linear

p = α + β* d + γ*s + µ

where:

p = ln(P)

d = ln(G - t )

s = ln(Ṁ/P) = ln(Ṁ) – ln(P)

β= elasticity of p w.r.t deficits

γ = elasticity of p w.r.t. seigniorage

preliminary model estimation
Preliminary Model – Estimation
  • The following VAR modeled to discern a long-run relationship between deficit and seigniorage:

y(t) = μ + ∏(1)y(t-1) + ∏(2) y(t-2) + ℮(t)

where

y(t)′ = (y(1t), y(2t))

y(1t) = seiniorage

y(2t) = deficit

℮ (t) ′ = (℮(1t), ℮(2t)

preliminary model results
Preliminary Model – Results
  • Johansen approach yields a stable long-run relationship between deficit and seiniorage given by:

s = 0.447d + residual (C1)

  • To finance a 1% increase in fiscal deficit in the long run, seigniorage would increase by 0.447% on average, ceteris paribus.
the final model results
The Final Model – Results
  • Again a VAR estimated
  • The Johansen procedure yields a stable long-run relationship at 5% level of significance:

p = 0.0349d + 1.1535s + residual(C2)

  • A 1% increase in deficit increases expected inflation by 0.0349% ceteris paribus.
  • A 1% increase in seigniorage increases expected inflation by 1.1535% ceteris paribus.
summary findings
Summary & Findings
  • In Pakistan, inflation is highly elastic to monetary expansion:

a 1%  in seiniorage (money creation) 1.15% price hike, ceteris paribus.

  • Direct impact of d on p:

a 1%in deficits  0.0349% in expected inflation, ceteris paribus.

  • Indirect impact of d on p:

a 1%in deficits  0.447%  in seiniorage 0.516% price hike, ceteris paribus.

policy implication
Policy Implication

FISCAL ADJUSTMENT IS NECESSARY

FOR UNDERTAKING A

PRICE STABILIZATION POLICY

IN PAKISTAN

conclusion
Conclusion
  • Apparent cause of inflation may be monetary but true dynamics of macro-economic instability go deeper - persistence of fiscal deficit financed largely if not entirely by seiniorage.
  • Effective stabilization policy must be designed in accordance.