Modeling Dynamics of Exchange Rates Volatility: A Case of Pakistan from 1980-2010

Abstract

The thesis aims to analyze the exchange rate volatility that exists in Pakistan. What threats does this volatility pose to various macroeconomic variables of the country? This is the main question that is being addressed in this thesis. The study also aims to look at the implications of the various exchange rate regimes followed in the country, upon some of the core variables such as inflation, trade, foreign direct investment etc. Both the official exchange rate and the real effective exchange rates are taken into account to look at the extent to which they get affected by different core variables, and vice versa. The paper also sheds light on the role of the State Bank of Pakistan, in reducing the fluctuations and the annual volatilities in the currency. How autonomous are its operations? How transparent is the State Bank of Pakistan? All such questions are addressed in this thesis. An OLS approach is being used to carry out a time series analysis, and the data is gathered for the 30 years from 1980 to 2010. The data was collected from various databases that were accessible. It is made sure that these sources were authentic and recognized. The findings of the paper mainly focus on the significance of their relation with the official and the real effective exchange rates. The study shows that the real effective exchange rate is more sensitive to current account balance, aid and foreign private investment as compared to the official exchange rate. It can also be seen that inflation and foreign direct investment are closely linked to the exchange rates.