This dissertation examines the exchange rate channel of monetary policy in Pakistan. Besides the exchange rate pass-through effect of prices, this study also tests whether the exchange rate can be used as an alternative monetary policy instrument for the monetary policy of Pakistan or not?. We applied cointegration, impulse response and variance decomposition analysis in the framework of vector autoregression, using monthly data from July 1991 to June 2009. Our empirical results suggest that output in the long run relationship is positively related to imports and real effective exchange rate, but negatively related domestic price level and real interest rate. The generalized impulse response and variance decomposition analysis suggest that a positive shock to exchange rate results into exchange rate pass-through, affecting domestic price level; but the pass-through effect is weak and incomplete covering a period of almost four months. Exchange rate is not sufficient monetary policy instrument to predict both the output and prices in the short run in Pakistan Supervisor:- Dr. Muhammad Arshad Khan