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


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


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


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.






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.

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