Impact of Monetary Policy Shocks and Exchange Rate on Trade Balance in Pakistan: A Vector Autoregressive Model Approach

Abstract

This study examines the effect of fluctuations in exchange rates and shocks to monetary policy on Pakistan's trade balance. The monthly time series data from January 2005 to December 2021 will be utilized for this study. Zivot Andrew structural unit root test has been used to assess the stationarity and structural breaks in the data series. The ARDL VEC model has been used to identify the long-run relationship due to different orders of integration among the series. In particular, the response of the trade balance towards shocks, exchange rate fluctuation and monetary policy shocks has been examined using the Vector Autoregressive model. It has been observed that the contractionary monetary policy has positively affected the balance of trade in the country, while the exchange rate shock at first showed a beneficial effect on the balance of trade in the country. Still, later on, that influence was neutralized, which means a policy of depreciating the currency to boost trade may not give fruitful results.