1. Is Inflation a fiscal phenomenon in Pakistan? Is Inflation a fiscal phenomenon in Pakistan? By Hamna Ahmed Department of Economics, University of Warwick.

2. To answer this question we will be looking at the following variables: Fiscal deficits Fiscal deficits D = G – t Seiniorage Seiniorage S = M – M (-1) /P Price level Price level

3. Motivation Inflation in Pakistan: Inflation in Pakistan: Persistent Persistent Ever-increasing Ever-increasing A serious challenge A serious challenge

4. Objective A simple model has been designed to assess: Direct Impact of d on p: d aggregate demand p Indirect Impact of d on p: d s by printing money p

5. A Step-wise Approach Step I Step I A preliminary model – any meaningful long-run relationship between deficit & seiniorage? Step II Step II The final model – all three variables tested jointly.

6. Channel 1 direct Channel 2 to 3 indirect 32 Fiscal DeficitsInflationSeigniorage Direct & Indirect Impact illustrated 1

7. Methodology Johansen approach to co-integration analysis Johansen approach to co-integration analysis Interested in long-run dynamics only because…. Interested in long-run dynamics only because…. Data – annual time series, Data – annual time series, Sample period: 1956 – 2005, Source: IFS repository.

8. Model Specification Model Specification – log-linear Model Specification – log-linear p = α + β * d + γ *s + µ where: p = ln(P) d = ln(G - ) s = ln( /P) = ln( ) – ln(P) β = elasticity of p w.r.t deficits γ = elasticity of p w.r.t. seigniorage

9. Preliminary Model – Estimation The following VAR modeled to discern a long-run relationship between deficit and seigniorage: The following VAR modeled to discern a long-run relationship between deficit and seigniorage: y(t) = μ + (1)y(t-1) + (2) y(t-2) + (t) where y(t) = (y(1t), y(2t)) y(1t) = seiniorage y(2t) = deficit (t) = ((1t), (2t) (t) = ((1t), (2t)

10. Preliminary Model – Results Johansen approach yields a stable long-run relationship between deficit and seiniorage given by: Johansen approach yields a stable long-run relationship between deficit and seiniorage given by: s = 0.447d + residual (C1) To finance a 1% increase in fiscal deficit in the long run, seigniorage would increase by 0.447% on average, ceteris paribus. To finance a 1% increase in fiscal deficit in the long run, seigniorage would increase by 0.447% on average, ceteris paribus.

11. The Final Model – Results Again a VAR estimated Again a VAR estimated The Johansen procedure yields a stable long-run relationship at 5% level of significance: The Johansen procedure yields a stable long-run relationship at 5% level of significance: p = 0.0349d + 1.1535s + residual (C2) A 1% increase in deficit increases expected inflation by 0.0349% ceteris paribus. A 1% increase in deficit increases expected inflation by 0.0349% ceteris paribus. A 1% increase in seigniorage increases expected inflation by 1.1535% ceteris paribus. A 1% increase in seigniorage increases expected inflation by 1.1535% ceteris paribus.

12. Summary & Findings In Pakistan, inflation is highly elastic to monetary expansion: In Pakistan, inflation is highly elastic to monetary expansion: a 1% in seiniorage (money creation) 1.15% price hike, a 1% in seiniorage (money creation) 1.15% price hike, ceteris paribus. Direct impact of d on p: Direct impact of d on p: in expected inflation, a 1% in deficits 0.0349% in expected inflation, ceteris paribus. Indirect impact of d on p: Indirect impact of d on p: in seiniorage 0.516% price hike, a 1% in deficits 0.447% in seiniorage 0.516% price hike, ceteris paribus.

13. Policy Implication FISCAL ADJUSTMENT IS NECESSARY FOR UNDERTAKING A FOR UNDERTAKING A PRICE STABILIZATION POLICY IN PAKISTAN

14. Conclusion Apparent cause of inflation may be monetary but true dynamics of macro-economic instability go deeper - persistence of fiscal deficit financed largely if not entirely by seiniorage. Apparent cause of inflation may be monetary but true dynamics of macro-economic instability go deeper - persistence of fiscal deficit financed largely if not entirely by seiniorage. Effective stabilization policy must be designed in accordance. Effective stabilization policy must be designed in accordance.