Quantity Theory of Money

Table of Contents

1. Introduction 3

1.1. Objectives 4

2. Literature Review 5

3. Methodology or Model 7

4. Data Sources and Construction of Variables 8

4.1. Contraction of Variables:- 8

5. Estimation Technique 8

6. Empirical Results 9

7. Conclusion 11

Abstract

This paper attempts to investigate the linkage between the excess money supply growth and inflation in Pakistan and to test the validity of the view that inflation is a monetary phenomenon. The results from the analysis indicate that there is a positive association between money growth and inflation. The money supply growth at first affects real GDP growth and at the second round it affects inflation in Pakistan. The important finding from the analysis is that the excess money supply growth has been an important contributor to the rise in inflation in Pakistan during the study period, thus supporting the argument that inflation in Pakistan is a monetary phenomenon. This may be due to the loose monetary policy adopted by the State Bank of Pakistan to show the high priority of the growth objective. The important policy implication is that inflation in Pakistan can be cured by a sufficiently tight monetary policy. The formulation of monetary policy must consider development in the real and financial sector and treat these sectors as constraints on the policy.

  Introduction

The expansionary economic policies of the government and the SBP over the last few years resulted in improvement in various macroeconomic indicators including Gross Domestic Product (GDP) growth, which remained above 6 percent during 2004-06. Despite this impressive performance of the economy, some worrisome factors have also appeared on the scene. The most significant of these factors is inflation, which remained above 8 percent during the last two years.

In 2004-05, average CPI inflation was 9.3 percent and on the basis of 12 month changes, inflation was recorded at 11 percent in April 2005. Several...