A Model for Monetary Policy Analysis in Pakistan: The Role of Foreign Exchange and Credit Markets

The IGC has supported an ongoing program to develop and use a Dynamic Stochastic General Equilibrium (DSGE) model for monetary policy analysis in Pakistan. Previous projects have designed a DSGE model suitable for Pakistan, used it to examine important monetary policy issues, and made the model ready for operation at the State Bank of Pakistan (SBP). The present project undertakes important extensions of the model to explore the role of foreign exchange and credit markets in determining the macroeconomic effects of monetary policy. Monetary policy plays an important role in advanced countries in controlling inflation and stabilizing economic activity. Foreign exchange and credit markets in these countries represent important channels for the transmission of monetary policy effects. In Pakistan, credit markets are less developed and international capital flows are less dominant in the foreign exchange market. The project incorporates these differences in the model and explores how they influence the effectiveness of monetary policy.