Leaning Against the Wind: The Cost-Benefit Analysis of Monetary Policy in Pakistan
Author: Zareen Afzaal

The rising interest rates in Pakistan have become a significant, current issue. Whether these rising interest rates pose a threat to the economy or not, is the basic question at hand. This study aims to determine the numerical values of the costs and benefits of the monetary policy‟s leaning against the wind (LAW) using sensitivity analysis. The underlying models of this sensitivity analysis are the Dynamic Stochastic General Equilibrium Models (DSGE) and the Variance Autoregressive Models (VAR). The study covers a twenty year time span ranging from 1998-2017. The estimates of probability of a future financial crisis, the crisis duration and magnitude of a crisis were acquired. Thereby, adding the marginal benefit from a lower probability of a crisis and marginal benefit from a smaller magnitude of a crisis, the total marginal benefit was obtained, which was then subtracted from the marginal cost which too was calculated, using certain estimates and assumptions. Impulse response functions were also obtained using various series of variables, such as, the unemployment rate, debt-to-income ratio, real debt and lastly, the probability of a crisis. One unit (positive) shock to the policy rate (interest rate) was given and its impact on all the series mentioned above was gauged. The results of this study indicate that as we move from non-leaning (NL) towards leaning against the wind (LAW), the costs increase and the benefits decrease, respectively. On that basis, it is recommended that the State Bank of Pakistan should avoid leaning against the wind and further tightening of the monetary policy. However, further research is required on the calculation of certain components used in this study, such as, the possibility of a crisis occurring (probability), the magnitude of that crisis and the time duration for which that crisis can persist. Supervisor:- Dr. Ahsanul Haq Satti

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Supervisor: Ahsan ul Haq Satti

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