Exchange market pressure and monetary policy: A case study of Pakistan

HF Commerce;HG Finance

Gilal, Muhammad Akram ; Ronald, Macdonald

University:University of Glasgow

Department:Adam Smith Business School

关键词: Monetary Policy Foreign Exchaneg Intervention Exchange Market Pressure;   

Others  :  http://theses.gla.ac.uk/3394/1/2011gilalphd.pdf

来源: University of Glasgow

【 摘 要 】

Exchange Market Pressure refers to money market disequilibrium that arises due to non-zeroexcess demand for domestic currency in the foreign exchange market. Exchange rate changesreflect the extent of market pressure in the absence of Central Bank intervention. It is arguedthat nominal exchange rate changes have consequences for domestic macroeconomicvariables. These include domestic output growth, increase in domestic prices, balance of trade,firms’ price-setting behaviour in high inflation countries, foreign debt burden of the country,balance of payments and the stability of the domestic financial system. It has been observedthat the Central Banks generally intervene in the foreign exchange market to avoid theseundesirable consequences of exchange rate changes. In this thesis, we construct exchangemarket pressure and intervention index for Pakistan using Weymark’s (1995) approach. Thebasic objective is to identify whether it is downward or upward pressure that has remaineddominant over the entire sample period. Based on intervention index values, we evaluate theCentral Bank’s monetary policy over the given sample period. In addition, we also calculatethe actual exchange rate and predicted exchange rate using one period lagged exchange rate.We check whether monetary policy is successful in its objective of reducing exchange ratevolatility. Finally, we also evaluate the determinants of exchange market pressure in a panel often countries. The first empirical chapter utilises difference data and the two-stage least squareapproach. In the second empirical chapter we adopt Johansen’s (1988) cointegration approach.Both of these provide evidence of downward pressure and active Central Bank intervention.Furthermore, these chapters show that the Central Bank’s foreign exchange intervention policyis fairly successful in achieving its objective of reducing exchange rate volatility. The initialempirical chapters use a fixed parameter approach. This has the disadvantage that it does notallow the estimated parameters to take account of structural changes. A third empirical chapteraddresses this issue and uses the Kalman Filter Time Varying Parameter approach. This has the advantage of allowing the parameters to take account of the effects of structural changeson parameter constancy. The results show unstable estimated parameters. The constructedexchange market pressure and intervention index show downward pressure and the activeCentral Bank intervention. Thus, this chapter further confirms our earlier findings ofdownward pressure and active Central Bank intervention. However, despite unstable estimatedparameters, Central Bank intervention policy is successful in reducing exchange rate volatilitywhich is unexpected. In the earlier empirical chapters, we assumed direct Central Bankintervention. However, there may be the case that Central Bank may use interest rate forfending off speculative attack. In such a case it is better to include interest rate as componentof exchange market pressure to truly reflect the extent of foreign exchange marketdisequilibrium. Last empirical chapter overcomes this issue and uses Eichengreen et al. (1996)approach for constructing exchange market pressure. It consists of percent changes inexchange rate, relative interest rate differential and relative percent changes in foreignexchange reserves. Furthermore, in this chapter, we evaluate the determinants of exchangemarket pressure in a panel of ten countries. The results indicate the relevancy of somemacroeconomic variables and measures of openness.