Effects of Exchange Rate on Inflation Rate in Pakistan

Abstract

The main objective of the research is to explore the impact of the exchange rate (ER) on the inflation rate (INF) in Pakistan. This study used data from 1975 to 2019 for Pakistan and utilised Autoregressive Distributed Lag (ARDL) procedures to analyse the data. This research found that devaluation of the Pakistani Rupee against the dollar has a positive and significant impact on the inflation rate in the long run (LR) but has an insignificant effect on INF in the short run (SR). The money supply (MS) has a positive and noteworthy impact on the inflation rate. The population growth (POP) has a positive and noteworthy effect on the INF in the LR only. The government investment (INV) has a positive and noteworthy effect on the inflation rate in the LR but has an inconsequential effect on INF in the SR. The study concluded that the devaluation of the Pakistani Rupee against the dollar has a noteworthy effect on the inflation rate in the long run only and strongly supports the Turnovsky and Kaspura (1974) theory of the association between inflation and exchange rate. The government needs to focus on the stability of the domestic currency to control the price level and to increase exports and investment to maintain the domestic price level and increase production. The SBP needs to regulate the MS to sustain the price level, and the government needs to control population growth to maintain the price level.