Pro-Cyclicality of monetary policy with Graduation, Institutions and governance: A case study of Pakistan

Abstract

Monetary policy role in stability has immense importance especially in the perspective of institutions and governance of a country.  This policy performs well in the presence of well-functioning institutions and good governance. Generally, monetary policy adopted by the developed countries is counter cyclical whereas developing economies like Pakistan adopt pro-cyclical policy. Although, developing economies’ institutional qualities are key elements in determining their ability to graduate. Ordinary Least Square (OLS) and Two Stage Least Square (2SLS) techniques are applied to evaluate that monetary dogma is either counter cyclical in nature or pro-cyclical in Pakistan.  It is established that monetary strategy is pro-cyclical. High profile institutions and good governance is indispensable for counter cyclical monetary policy. Pro-cyclical policy is taken on due to low performing institutions with their lower qualities and poor governance. The financial institutions should take the appropriate measures to manage the pro-cyclical approach of monetary policy. This is one of the initial studies that investigate the cyclicality nature of monetary 
strategy and role of institutions and governance in Pakistani context.