Effectiveness of monetary policy: Application of modified Peter and Clark (PC) algorithms under Graph-Theoretic Approach

Authors

  • Rizwan Fazal Quaid-e-Azam University
  • Md. Shabbir Alam University of Bahrain
  • Umar Hayat University of Swat
  • Naushad Alam Dhofar University

DOI:

https://doi.org/10.47743/saeb-2021-0019

Keywords:

monetary policy, inflation, causality, Graph theory

Abstract

It is common practice that central banks around the world must adopt an inflation targeting framework; based on the assumption that inflation could be reduced by increasing interest rates. On contrary, the theoretical literature and data-based evidences differ remarkably. The arduous attached in finding the true association and causation is the existence of multiple monetary transmission channels. Theoretical literature lists both monetary and non-monetary channels linking interest rate and inflation. However, most of the existing studies are focused on single equation model ignoring other parallel channels. This study is first of its kind where we have developed modified Peter and Clark (PC) algorithm of the Graph-Theoretic approach taking all the monetary and non-monetary channels to determine the causal nexus between monetary policy and inflation. The results show that, causality is running from interest rate towards inflation; suggesting a positive and significant long run relationship of interest rate with inflation in case of Pakistan. Furthermore, monetary policy have cost-side effects on inflation; however, the monetary policy becomes counterproductive whenever high interest rate is used to decrease cost push inflation. Therefore, there is need of serious rethinking about current monetary policy regime.

JEL Codes - E4; E5; E42; E52

Author Biographies

Rizwan Fazal, Quaid-e-Azam University

Pakistan Institute of Development Economics (PIDE)

Md. Shabbir Alam, University of Bahrain

Department of Economics & Finance, College of Business Administration

Umar Hayat, University of Swat

Department of Economics and Development Studies

Naushad Alam, Dhofar University

Department of Finance and Economics, College of Commerce and Business Administration

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Published

2021-09-27

How to Cite

Fazal, R., Alam, M. S., Hayat, U., & Alam, N. (2021). Effectiveness of monetary policy: Application of modified Peter and Clark (PC) algorithms under Graph-Theoretic Approach. Scientific Annals of Economics and Business, 68(3), 333–344. https://doi.org/10.47743/saeb-2021-0019

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