The Effect of An Increase in Money Supply On GDP, Price and Interest Rate” Case study of Pakistan (1982-2016)

Abstract

Money supply is a key variable in many monetary models, as its fluctuations significantly influence output, prices, and interest rates within an economy, particularly in developing countries such as Pakistan. This study aims to examine whether changes in money stock affect major macroeconomic indicators—namely interest rates, output, and inflation—in Pakistan, using annual data from 1982 to 2016. The results of the Johansen–Juselius co-integration test confirm the existence of a long-run relationship between the dependent variable, broad money (M2), and the independent variables, including Gross Domestic Product (GDP), Consumer Price Index (CPI), and the money market rate. Furthermore, the Error Correction Model (ECM) results indicate a significant short-run relationship between money supply (M2) and these macroeconomic variables. The normalized co-integration coefficients reveal that the signs of GDP and the money market interest rate are consistent with theoretical expectations. However, the negative coefficient of CPI suggests that increases in money supply are not associated with higher inflation in the case of Pakistan. Additionally, the results of the Granger causality test indicate a bidirectional causal relationship between money stock (M2) and CPI. In contrast, GDP and the money market rate exhibit a unidirectional causal relationship running toward money supply.

Money Supply, Ganger Causality, Money Market Rate