Macroeconomic Impacts of External Shocks on Economy: Recursive Vector Autoregressive (RVAR) Analysis

Authors

  • Muhammad Zeeshan Younas School of Economics, Quaid-I-Azam University, Islamabad, Pakistan Author
  • Muhammad Arshad Khan Department of Economics, COMSATS University, Islamabad, Pakistan Author

Keywords:

External shocks, oil price and foreign interest rate shocks, Recursive, GRIFs, GFEVDs

Abstract

This study examines the short run analysis of external shocks impact on Pakistan’s economy. We applied the

 

Recursive Vector Autoregressive (RVAR) methodology using the monthly data over the period 2001M1 to

 

2016M12. We examine impact of external shocks like oil price shocks and foreign interest rate shocks on the

 

macro variables of Pakistan economy. These macro variables include inflation rate, output, interest rate,

 

money supply and real effective exchange rate. We also analyze the transmission channels of these external

 

shocks on domestic economy. Then we applied impulse response function on both external shocks (oil price

 

and foreign interest rate). These impulse response functions concluded that oil price shocks have inflationary

 

pressure on Pakistan economy while foreign interest rate shocks have minor impact on Pakistani

 

macroeconomic variables except real effective exchange rate. According to impulse response function

 

analysis, when oil price shock arises inflation immediately increases while the foreign interest rate shocks

 

have no serious effects on domestic macroeconomic variables. However, the changes in foreign rate of

 

interest have effect on real effective exchange rate. On the basis of generalized impulse response function,

 

our findings are supported by generalized forecast error variance decompositions analysis. This

 

decomposition analysis clearly supporting the impulse response functions that revealed that oil price shocks

 

have inflationary impact on Pakistan economy while foreign interest rate changes have minor impact on

 

domestic variables. However, real effective exchange rate is majorly affected by foreign interest rate. In sum

 

up, these external shocks are strengthening the stagflation in Pakistan. Policy makers should make viable

 

policy to cope this problem and take into account these shocks during policy making. To minimize the Oil

 

price shocks inflationary pressures on the economy, we should focus on alternative renewable sources of

 

energy sector like solar plant.

Published

2018-10-20

Issue

Section

Articles

How to Cite

Younas, M. Z. ., & Khan, M. A. . (2018). Macroeconomic Impacts of External Shocks on Economy: Recursive Vector Autoregressive (RVAR) Analysis. Bulletin of Business and Economics (BBE), 7(4), 169-184. https://bbejournal.com/index.php/BBE/article/view/160

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