Pakistan Economic and Social Review - Lahore

PAKISTAN ECONOMIC and SOCIAL REVIEW

School of Economics, University of the Punjab, Lahore
ISSN (print): 1011-002X
ISSN (online): 2224-4174

THE PREDICTIVE POWER OF MONEY FOR INFLATION AND ECONOMIC ACTIVITY: THE MODERATING ROLE OF ASSET PRICES

  • Hina Shafiq/
  • Wasim Shahid Malik/
  • December 31, 2021
Keywords
Asset Prices, Money, Predictive Power, Moderating Role
Abstract

In the past three decades the focus of researchers and policy makers shifted from money to interest rate as monetary policy instrument owing to low predictive and explanatory power of the former for the target variables – real economic activity and the inflation rate. In this study, we hypothesize that the apparent weak relationship between money and the target variables, found in empirical literature, is predominantly due to the absence of asset prices in the empirical models (see for instance, Bernanke and Blinder, 1992). We test our hypothesis using data of the Pakistan economy over the period 1981 Q1 to 2018 Q2. We compare the forecasting power of interest rate with that of money stock for goods prices and real economic activity in the presence of asset prices. This has been done using Granger causality test and by decomposing variances of the GDP deflator rate and output. In both cases, the predictive power of money, for the prices and output, significantly increases when asset prices are considered in the model. Moreover, as a second objective, we also find out the moderating role that asset prices play in strengthening or weakening the relationship between money and the target variables. This has been done using two different methods; the two steps regression based method and by incorporating an interaction term of asset prices and money in the regressions of the target variables. In both cases, we find evidence of asset prices affecting the relationship between money and the target variables. More specifically, the asset prices proved to weaken the relationship between money and price level and strengthen the relationship between money and the economic activity. The study is important in two respects; the role of asset prices in prediction of money for the prices and output has been contributed to the empirical literature of Pakistan and the results have strong policy relevance.

References

Agha, A. I., Ahmed, N., Mubarik, Y. A., & Shah, H. (2005). Transmission Mechanism of Monetary Policy in Pakistan. SBP-Research Bulletin 1:1.

Altissimo, F., Georgiou, E., Sastre, T., Valderrama, M.T., Sterne, G., Stocker, M., Weth, M., Whelan, K. & Willman, A. (2005). Wealth and Asset Price Effects on Economic Activity, in: European Central Bank Occasional Paper Series, No. 29.

Arby, M. F. (2008). Some Issues in the National Income Accounts of Pakistan (Rebasing, Quarterly and Provincial Accounts and Growth Accounting), PhD Dissertation, Pakistan Institute of Development Economics, Islamabad.

Barro, R. J. (1978). Unanticipated Money, Output and the Price Level in the United States. Journal of Political Economy, Vol 86. No.4, pp 3-30.

Barro, R. J. (1977). Unanticipated Money Growth and Unemployment in the United States. The American Economic Review, Vol 67. No.2, pp 101-115.

Barron, R.M., & Kenny, D. A. (1986), The Moderator Mediator Distinction in Social Psychological Research: Conceptual, Strategic and Statistical Considerations. Journal of personality and social psychology, Vol, 51, No.6, pp 1173-1182.

Bernanke, B. S. (1986). Alternative Explanation of the Money-Income Correlation. NBER Working paper series, No.1842.

Bernanke, B. S., & Blinder, A. S. (1992). The Federal Funds Rate and the Channels of Monetary Transmission. The American Economic Review, Vol. 82, Issue. 4, pp 901-921.

Christiano, L. J. & Ljungqvist, L. (1988). Money does Granger-cause output in the bivariate money-output relation. Journal of Monetary Economics, Elsevier, vol. 22(2), pages 217-235, September.

Chaudhry, I. S., Ismail, R., Farooq, & F., Murtaza, G. (2015). Monetary Policy and Its Inflationary Pressure in Pakistan. Pakistan Economic and Social Review. 53(2), pp 251-268.

Enders, W. (2014), “Applied Econometric Time Series”, John Wiley and Sons, USA.

Estrella, A., & Mishkin, F. S. (1997). Is There a Role for Monetary Aggregates in the Conduct of Monetary Policy? Journal of Monetary Economics, 40(2), 279-304.

Friedman, M. & Schwartz, A. (1963). A Monetary History of the United States, National Bureau of Economic Research, Princeton University Press: Princeton.

Gordon, R. J. (1982). Price Inertia and Policy Ineffectiveness in the United States, 1890-1980. Journal of Political Economy, Vol.90, No. 6.

Government of Pakistan (2015). Hand Book of Statistic on Pakistan Economy, State Bank of Pakistan.

Government of Pakistan (Various years). Pakistan Economic Survey, Ministry of Finance, Islamabad.

Ghumro, N. H., & Memon, P. A. (2015). Determinants of Inflation: Evidence from Pakistan using Autoregressive Distributed Lagged Approach. Journal of Management and Business. 2(1).

Hanif, M.N., Iqbal, J., & Malik, M. J. (2013). Quarterization of National Income Accounts of Pakistan. SBP working paper series, No. 54.

Kemal, A. (2006). Is Inflation in Pakistan a Monetary phenomenon? Pakistan Development Review, 45: 213–220.

King, R. J., & Watson, M. W. (1996). Money, Prices, Interest rates and Business Cycle. The Review of Economics and Statistics. Vol. 78, No. 1, pp 35-53.

Litterman, R. B., & Weiss, L. (1985). Money, Real Interest Rates, and Output: A Reinterpretation of Postwar U.S. Data. Econometrica, vol. 53, 129-56.

Lucas, R. J. 1972. Expectations and the neutrality of money.  Journal of Economic Theory, Elsevier, vol. 4(2), 103-124.

Malik, W. S. (2010). Taylor Rule and Macroeconomic Performance in Pakistan. Pakistan Development Review, Vol.49, No.1, 37-56.

McCallum, B. T. (1983). A reconsideration of the Sims' evidence concerning monetarism. Economic Letters. Vol. 13. Pp 167-171.

Mishkin, F. S. (1982). Does anticipate Monetary Policy Matter? An econometric investigation. Journal of Political Economy, Vol. 90, No.1.

Morck, R., Shleifer, A., & Vishny, R. W. (1990). The Stock Market and Investment: Is the Market a Sideshow? Brookings Papers on Economic Activity, 1990(2), 157-215.

Qayyum, A. (2006), Money, Inflation, and Growth in Pakistan, The Pakistan Development Review, 45(2), 203-212.

Sargent, T. J., & Wallace, N. (1975). Rational Expectations, the Optimal Monetary Instrument, and the Optimal Money Supply Rule.  Journal of Political Economy, University of Chicago Press, 83(2), 241-254.

Shafiq, H., & Malik, W. S. (2018). Money Demand Function Revisited: The Role of Asset Prices in Pakistan. Pakistan Economic and Social Review, 56(1), 67-92.

Shafiq, H., & Malik, W. S. (2019). Asset Prices and Business Cycle Fluctuations: The Role of Money Revisited. Unpublished Doctoral Dissertation, Quaid-i-Azam University Islamabad, Pakistan.

Sims, C. A. (1972). Money, Income, and Causality. American Economic Review, Vol.62, 540-52.

Sims, C. A. (1980). Comparison of Interwar and Post-war Business Cycles: Monetarism Reconsidered. American Economic Review, 70, 250-7

Stock, J. H., & Watson, M.W. (1989). New Indexes of Coincident and Leading Economic Indicators. in NBER Macroeconomics Annual 1989. O.J. Blanchard and S. Fischer, eds., pp. 352-94.

Stock, J. H. & Watson, M.W. (1999a). Business Cycle Fluctuations in U.S. Macroeconomic Time Series, in Handbook of Macroeconomics, Vol. 1. J.B. Taylor and M. Woodford, eds. pp. 3-64.

Stock, J. H. & Watson, M.W. (2003). Forecasting Output and Inflation: The Role of Asset Prices. Journal of Economic Literature, Vol. XLI, pp 788-829.

Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton, N.J. Princeton University Press.

Statistics

Author(s):

Hina Shafiq

Assistant Professor

Department of Economics, Sardar Bahadur Khan Women’s University, Quetta.

Pakistan

  • hinasbk@hotmail.com

Wasim Shahid Malik

Professor SBP Chair,

University of Peshawar, Peshawar.

Pakistan

  • wsmalick@gmail.com

Details:

Type: Articles
Volume: 59
Issue: 2
Language: English
Id: 61fcd90e3e760
Published December 31, 2021

Statistics

  • 167
  • 70
  • 70

Copyrights

The research published by Pakistan Economic and Social Review (PESR) is licensed under Creative Commons Attribution 4.0 International License. It allows readers to Share_ copy and redistribute, Adapt_ remix and transform. PESR offers free full text downloading to its online contents to all readers. No subscription fee is required to read and download online articles.
Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.