The Price Puzzle and Monetary Policy Transmission Mechanism in Pakistan: Structural Vector Autoregressive Approach

Publication Year : 2010

The prime objective of economic policies is to increase the welfare of the general public and the monetary policy supports this broad objective by focusing its efforts to promote price stability. The growing importance of monetary policy stabilisation efforts may reflect both political and economic realities. Understanding the transmission mechanism of monetary policy to inflation and other real economic variables is imperative for central bankers to conduct monetary policy effectively. High inflation reduces growth by reducing investment and productivity growth which reduces the welfare, gives a theoretical foundation for the choice of price stability as an objective of monetary policy. These arguments about monetary policy objectives lead to the choice of price stability as the single or primary objective of monetary policy. Monetary policy is one of the important tools with the monetary authorities to achieve the objectives of price stability. There is extensive theoretical as well as empirical literature available on the effects of monetary policy shocks on the real economic aggregates and prices.