Empirical Analysis of Monetary Transmission Mechanism in Pakistan

Monetary transmission mechanism is extremely important for central bank of every country to conduct an effective monetary policy. Monetary policy of developing countries i.e. Pakistan are constrained by international economic institutions. This research work investigates the nature and strength of monetary transmission mechanism and its channels by considering the external constraints on the monetary policy of Pakistan. VAR model with exogenous vector and seasonally adjusted quarterly data of different domestic and foreign variables over the period 2001:Q3 to 2011:Q2 have been used for this purpose. Surprisingly, price puzzle vanished after including external constraints to our monetary policy in our benchmark model. Bank lending channel is found to be efficient and significant in the transmission of monetary shock to the real output. Moreover, empirical results also indicate that asset price channel and exchange rate channel are not significant in propagation of monetary policy shock in Pakistan. This research would help economic researchers and policy makers of developing countries to analyze the effectiveness of monetary policy in a better way.