Pakistan Institute of Development Economics


Exploring Channels of Economic Linkages of Pakistan’s Economy to the Globe

The globalisation of international economies has important implications for policy- makers, short- and long-term investors and businesses leaders. Globalisation implies that the power of local policy-makers in controlling and manipulating the economy is limited since the economic managers have to keep an eye not only on the local economic conditions but also on the shocks originating outside their economy. An economy encompasses several aspects e.g. financial, monetary, real sectors and foreign trade, therefore a multidimensional set of variables is required for measuring progress of an economy over time. In this paper we propose and apply the multivariate statistical technique of canonical correlation analysis to the study of linkages of Pakistani economy to the globe. This technique is used to investigate the extent to which Pakistani economy is affected by global economic development in particular the G-7 countries and China. This is achieved by representing the Pakistani economy as linear composites of macroeconomic and financial variables. Similar linear composites are determined for each of the G-7 countries and China. The coefficients of linear composite are selected so as to maximise the correlation between the two sets. The paper also investigates the channels of transmission of economic and financial development in these economies to Pakistani by investigating which Pakistani economic and financial variables are linked to the macroeconomic developments in these global economies. To this end, correlation between the individual observable macro and financial variables and the associated linear composite are estimated. It is found that there are several different types of channels of economic linkages with the G-7 countries and China with Pakistan. However inflation, exchange rate and stock price and to a lesser extent trade are found as important channels of international transmission of external shocks from these global economies to Pakistan.



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