Nexus Between Money Supply and Inflation in Pakistan

Abstract

This study examines the relationship between money supply and inflation in Pakistan using annual data from 2000-2024. The research aimed to empirically investigate the long-run relationship between money supply growth and inflation, to analyze the short-run dynamics and to assess the relative importance of inflationary persistence with identifying significant structural breaks in the inflation process in Pakistan. The empirical investigation proceeded through a structured sequence of tests by beginning with unit root tests which established a mixed order of integration among the variables therefore justifying the application of the ARDL bounds testing approach to cointegration. The core of the analysis involved estimating multiple regression models including contemporary dynamic distributed lag, and error correction model, followed by diagnostic and robustness checks to validate the findings. . The study concludes that there exists no significant long-run relationship between money supply growth and inflation. Instead, inflation is primarily driven by strong inertia, where previous inflation substantially influences current rates, alongside structural factors and external shocks like the COVID-19 pandemic. The real interest rate shows no significant impact on inflation. These results challenge conventional monetary policy approaches, indicating that inflation in Pakistan is not primarily a monetary phenomenon but stems from structural rigidities and persistent inflationary expectations.