Exchange market pressure and monetary policy: A case study of Pakistan

Gilal, Muhammad Akram (2011) Exchange market pressure and monetary policy: A case study of Pakistan. PhD thesis, University of Glasgow.

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Exchange Market Pressure refers to money market disequilibrium that arises due to non-zero
excess demand for domestic currency in the foreign exchange market. Exchange rate changes
reflect the extent of market pressure in the absence of Central Bank intervention. It is argued
that nominal exchange rate changes have consequences for domestic macroeconomic
variables. These include domestic output growth, increase in domestic prices, balance of trade,
firms’ price-setting behaviour in high inflation countries, foreign debt burden of the country,
balance of payments and the stability of the domestic financial system. It has been observed
that the Central Banks generally intervene in the foreign exchange market to avoid these
undesirable consequences of exchange rate changes. In this thesis, we construct exchange
market pressure and intervention index for Pakistan using Weymark’s (1995) approach. The
basic objective is to identify whether it is downward or upward pressure that has remained
dominant over the entire sample period. Based on intervention index values, we evaluate the
Central Bank’s monetary policy over the given sample period. In addition, we also calculate
the actual exchange rate and predicted exchange rate using one period lagged exchange rate.
We check whether monetary policy is successful in its objective of reducing exchange rate
volatility. Finally, we also evaluate the determinants of exchange market pressure in a panel of
ten countries. The first empirical chapter utilises difference data and the two-stage least square
approach. In the second empirical chapter we adopt Johansen’s (1988) cointegration approach.
Both of these provide evidence of downward pressure and active Central Bank intervention.
Furthermore, these chapters show that the Central Bank’s foreign exchange intervention policy
is fairly successful in achieving its objective of reducing exchange rate volatility. The initial
empirical chapters use a fixed parameter approach. This has the disadvantage that it does not
allow the estimated parameters to take account of structural changes. A third empirical chapter
addresses this issue and uses the Kalman Filter Time Varying Parameter approach. This has the advantage of allowing the parameters to take account of the effects of structural changes
on parameter constancy. The results show unstable estimated parameters. The constructed
exchange market pressure and intervention index show downward pressure and the active
Central Bank intervention. Thus, this chapter further confirms our earlier findings of
downward pressure and active Central Bank intervention. However, despite unstable estimated
parameters, Central Bank intervention policy is successful in reducing exchange rate volatility
which is unexpected. In the earlier empirical chapters, we assumed direct Central Bank
intervention. However, there may be the case that Central Bank may use interest rate for
fending off speculative attack. In such a case it is better to include interest rate as component
of exchange market pressure to truly reflect the extent of foreign exchange market
disequilibrium. Last empirical chapter overcomes this issue and uses Eichengreen et al. (1996)
approach for constructing exchange market pressure. It consists of percent changes in
exchange rate, relative interest rate differential and relative percent changes in foreign
exchange reserves. Furthermore, in this chapter, we evaluate the determinants of exchange
market pressure in a panel of ten countries. The results indicate the relevancy of some
macroeconomic variables and measures of openness.

Item Type: Thesis (PhD)
Qualification Level: Doctoral
Keywords: Monetary Policy Foreign Exchaneg Intervention Exchange Market Pressure
Subjects: H Social Sciences > HF Commerce
H Social Sciences > HG Finance
Colleges/Schools: College of Social Sciences > Adam Smith Business School > Economics
Supervisor's Name: Ronald, Professor Macdonald and Joseph, Dr. Byrne
Date of Award: 2011
Depositing User: Mr Muhammad Akram Gilal
Unique ID: glathesis:2011-3394
Copyright: Copyright of this thesis is held by the author.
Date Deposited: 24 May 2012
Last Modified: 10 Dec 2012 14:06

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