Pakistan Institute of Development Economics, Islamabad

Crude Oil Price, Monetary Policy and Output: The Case of Pakistan
Author(s): Afia Malik
Source: The Pakistan Development Review, Vol. 47, No. 4, Papers and Proceedings PARTS I and
II Twenty-fourth Annual General Meeting and Conference of the Pakistan Society of
Development Economists Islamabad, March 31-April 2, 2009 (Winter 2008), pp. 425-436
Published by: Pakistan Institute of Development Economics, Islamabad
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ThePakistan Review
Development
41: 4 Part
II (Winter
2008)pp.425-^36

Crude Oil Price, Monetary Policy and Output:

The Case of Pakistan

Afia Malik

I. INTRODUCTION
Rapid risesin thepricesof crudeoil in thedecade of 2000s have raisedconcerns
amongpolicy-makers aroundthe world,as the theoretical and empiricalliteraturehas
establishedthatoil priceshocksmayhave an adverseimpacton themacroeconomyof
thecountry.In particular, fortheoil importing developingcountrieslike Pakistan,this
upwardtrendin the price of oil can have seriousrepercussions in termsof creating
inflationarypressures in theeconomy,increasingbudget deficit
and balanceof payment
problems, and thus the
affecting GDP growth.
Pakistanwas on the pathof risingGDP growthin the firstseven yearsof this
decade. But in the year2007-08,thesituationhas changed.This oil priceshockcould
possiblybe one of thereasons.As an impactof risinggrowthrateof GDP, demandfor
energyhas also goneup rapidlyin thisperiod.In theenergymixfortheyear2005-06,oil
accountsfor32 percentof thetotalenergyused in Pakistan,and it is thesecondlargest
sourceof energyused afternaturalgas, whichaccountsfor39 percent.Withoil beingthe
secondlargestsourceof energyused along withalmostconstantrateof its production
Pakistanis heavilydependenton oil importsfromMiddle East exporters(Saudi Arab
playingthe lead role). Almost82 percentof thedemandforpetroleum productsin the
country is met through imports.1Pakistanspent about 44 of
percent exportearningson oil
imports in 2006-07. This percentage was only 27 percentin 2004-05. Therefore,the
internationaloil priceincreasehas a directimpacton themacroeconomyof thecountry,
especiallyon theoil priceGDP relationship.
The shareof netoil importsin GDP is an indicatorof therelativeimportance of
theoil priceriseto theeconomyin termsof thepotentialadjustments neededto offsetit.
ForPakistanoverthelastfewyears,thisratiohas risenfrom-3.13 in 1990-91to-5.24 in
2005-06 [Malik (2007)]. Withsucha highratio,unlesscountry is runningin surplus,or
has extremely large foreignexchangereserves,highoil priceis dealt by severemacro
economicadjustments.
The objectiveof thisstudyis to empirically analysetheimpactof oil priceon the
outputgrowth of Pakistan,usingthe simple model derivedwhileemployingmonetary

AfiaMalik<malik_afia@yahoo.com>is SeniorResearch
Economist
at thePakistan
Institute
of
Islamabad.
Economics,
Development
'Fordetailed
discussion
onthestate
oftheoilsector
inPakistan,
seeMalik
(2007).

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426 Malik
A//a

policyfunctionto an open economy.Secondly,thisstudywill examinethe non-linear

betweenoil pricesand output.If thereexistsa non-linear
relationship relationshipthen
whatis the thresholdlevel afterwhichit becomesnegative.Plan of the paper is this
introductionis followedby an overviewof literature. Section III will describethe
methodology and dataand SectionIV willexplaintheempiricalfindings.FinallySection
V is theconclusion.

II. AN OVERVIEW OF LITERATURE

The analysisof theimpactof oil priceshockson themacroeconomic variableshas
long been the subject of empirical literature.There is a consensus between
macroeconomists thatoil priceshockreduceseconomicactivityand increasesinflation
simultaneously. There are manystudieson the subject.Brunoand Sachs (1982) have
analysed in detailtheeffectsof oil pricesof the1970son outputand inflation. Theytook
the case of UK manufacturing and developeda theoretical model and concludedthat
higherinputpriceshaveplayeda significant rolein theslowdownsince 1973 throughout
the OECD. On the otherhand, Hamilton(1983) establishedempiricallya negative
relationship betweenoil prices and macroeconomic variables.Further, Hamiltonin a
seriesof studieson thesubject(in 1983, 1996,2000, and 2008) ascertaineda vitalrole
foroil priceincreasein mostof US recessions.He stressedtheimportance of oil prices
on themacroeconomic activities.
Later manyresearchers further supportingand extendingon Hamilton'searlier
work,while using different estimationproceduresand data testedthe relationships
betweenan oil priceincreaseanddifferent macro-economic variables[e.g.,Burbidgeand
Harrison(1984); Gisserand Goodwin(1986); Mork(1984); Hoover and Perez (1994);
Federer(1996); Lee, et al. (1995)]. Most of thestudieshave focusedon thedeveloped
countries,restatingthatoil prices may be an important factorin affecting economic
growth in the US and elsewhere. These studies
presentnumerous theoreticalperspectives
on the oil price shock hypothesis,as well as empiricalevidence on the estimated
magnitude of such shocksimpacting on growththrough some of thedirectand indirect
channels.
In addition,empiricalliteraturehas been shown an asymmetricrelationship
betweenoil priceshocksand economicrecession.Thatis, an increasein oil priceled to a
declinein GDP whilethedecreasein oil pricedoes notencouragetheeconomicactivity.
For instance,Federer(1996) focusedon threepossiblewaysto focuson theasymmetric
relationship:counterinflationary monetarypolicy, sectoralshocks, and uncertainty,
besidessomedirectchannelsthatincludesthemodelsof real balances(supposesthatoil
price increaseslead to inflationwhich lowers the quantityof real balances in the
systems),theincometransfer model(describingincometransfer betweenoil importing
and oil exportingcountries)and the potentialoutputmodel (suggestingthatoil and
capital are complements,so that an increasingoil price decreases the economy's
productivecapacity).He presumedthatsince the last threemodels have a symmetric
relationbetweenoil pricechangesand outputgrowth, therefore theycan be excludedas
thereis asymmetry in theoil prices.He findsa significantrelationship betweenoil price
increasesand counterinflationary policyresponses.At the same time oil priceincreases
help predictoutputgrowthirrespective of monetarypolicy variables. In addition,

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 OilPrice,
Crude andOutput
Policy
Monetary 427

monetary policyresponseto decreasein real oil pricescloselyresembleto themonetary

policyresponseto oil priceincrease.Therefore, asymmetric monetary policyresponses
can onlyexplaina partof theasymmetric oil price-output relationship.Further, sectoral
shocksanduncertainty channelscouldaccountforpartoftheasymmetry effects.
Similarly,Lee, et al (1995) also revealedthestability of asymmetric effectsin the
period before and after 1985 and whetheror not it depended on other variables.The
implication of thisliterature is that indirect
transmission mechanisms may be the crucial
meansby whichoil priceshockshavemacroeconomic impacts.In addition,Mork(1989),
Mork, et al (1994), Huang, et al (2005), Sadorsky(1999) also emphasisedthe
asymmetry of theimpactof oil priceshockson economicactivities.The basis fortheir
argument theoil pricedeclinesof themid-1980sduringwhichtheworldpriceof oil
was
halvedand thelinearrelationship betweenoil pricesand economicgrowthappearedto
breakdown.
On thesimilargrounds, Hooker(1996) challengedHamilton'sfindings thatsample
stabilityis important.Oil prices are endogenous,and that linear and symmetric
specifications misrepresent theformof theoil priceinteraction. He foundthatoil prices
do Grangercause a varietyof US macroeconomic indicatorsin dataup to 1973 butnotin
thedataafterwards. Oil priceswereexogenousbefore1973,butnotafterwards.
Guo and Kliesen(2005) also foundthenegativeand significant effectof oil future
priceson future grossdomesticproduct, andthiseffectbecomesmoresignificant afteroil
pricechanges are also included in theregression to controlfor the symmetric effect. His
findings were in confirmation with the Hamilton (19#6,2003), thatis, increase in the
price of oil matters less as compared to the future uncertaintyabout the directionof
prices.As theoil pricevolatility is mainlydrivenbyexogenouseventssuchas significant
terroristattacksand military conflictsin theMiddleEast. His findings provideeconomic
rationalesforHamilton's(2003) non-linearoil shock measure,as it capturesoverall
effects(bothsymmetric artdasymmetric) of oil shockson output. Hsing (2007, 2008)
focusedon thenon-linear relationship between realoutputandrealoil pricesapplyingthe
monetary policyfunction to an open economyand foundthecriticalvalue of oil prices
forGermany andUS.
Major portionof researchcarriedout so far is in the contextof developed
economies.Extremelylimitedresearchhas been done so farto studythe impactof oil
price shockson the economicactivityof developingcountries.There are few recent
studies. Rafiq, et al (2008) examinedthe impact of oil price volatilityon key
macroeconomicindicatorsof Thailand. Kumar (2005) assessed the oil price macro
economyrelationship forIndia. Cunado,et al (2005) focusedon six Asian countries
includingThailand,Singapore,SouthKorea,Malaysia,Phillipinesand Japanand studied
theimpactof oil price shockson botheconomicactivityand consumerprice indexes.
Finally,the objectiveof Jbir,et al (2008) studywas to examinethe oil price-macro
economyrelationship by analysingtheroleof subsidypolicyin Tunisia.These studiesin
general,confirmedthe negativeimpactof real oil priceson outputand othermacro
variables(e.g.,priceindex).
By and large theseempiricalstudieshave suggestedthe negativeimpactof oil
priceincreaseon oil importing economies.However,theextentof thisimpactdependson
thestructure of variouseconomies[Gounder,et al (2007)]. Now comingto thecase of

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428 Malik
A/ifl

Pakistan,no seriousattempt
has beenmadeso farto empiricallyexaminetheeffectof oil
To
prices. myknowledge thisis thefirst testingthedirectimpactof oil
studyempirically
priceshocks forPakistan.

III. METHODOLOGY AND DATA ISSUES

An increasein oil pricesis expectedto affectmacroeconomythroughvarious
channels.Theoretically, thereare different reasons why an oil shock should affect
macroeconomic variables,some of them demand a non-linearspecification of the oil
price-macroeconomyrelationship. For example, the oil shock can lead to lower
aggregate demandas theoil priceincreaseleadsto a transfer of incomefromimporting to
exporting countries[Hamilton(2003); Federer(1996)]. It changesthebalance of trade
betweencountriesand exchangerates.Net oil-importing countriesnormallyexperience
deterioration in theirbalanceof payments [Malik(2007)], putting downwardpressureon
exchange rates.As a result,imports become more expensive and exportsless valuable,
leadingto a dropin real nationalincome.These countriesare expectedto face a large
importbill,whichmightleads to thereduction in totaldemandforall imported goods so
as to restorebalanceof paymentsequilibrium. Or netexportsare expectedto declineif
the amountof oil importsand otherfactorsremainthe same. The only exceptionis
wherethecountry is running in surplusor has extremely largeforeign exchangereserves.
Further, oil priceincreasereducesaggregatesupplysince oil is used as an inputin the
production process,to generateelectricity and to transport outputto themarket.Higher
crudeoil price is expectedto raise the priceof petroleumproducts,thusincreasein
transport costs and electricity bills, etc. and it will leads to inflation, reduce non-oil
demandand lower investment in net oil importing countries,consequentlyhavinga
significant impacton employment and outputas well. It wouldreducereal wealthand
consumption spending.
Tax revenuesfalland thebudgetdeficitincreases,due to rigidities in government
expenditure which drivesinterest ratesup.2 For Barsky and Kilian (2004) is nottherise
it
of oil pricethatreducesthe economicactivity, but it is theresponseof the monetary
policyto the oil price shock.Furthernonlineareffecton economicactivitycould be
throughsectoralreallocationsof resourcesor disappointingirreversibleinvestment
through theireffects on uncertainty [Ferderer (1996)].
In addition,theadverseimpactof higheroil priceson oil-importing developing
countries is generally moreevidentformostindebtedcountries.3 Fiscal imbalanceswould
be aggravatedin thosedevelopingcountries thatprovidedirectsubsidieson oil products
to protectpoorhouseholdsand domesticindustry.4 The burdenof subsidiestendsto grow
as international pricesrise,addingto thepressureon government budgetsand increasing
politicalandsocial tensions.5
2For
detailed
transmission
mechanismthroughwhichoilprices
haveanimpactontherealeconomic
seeIAE(2004).
activity
3Pakistan
isamong thelistofhighly
indebtedcountries
[fordetails
seeSiddiqui
andMalik(2001
)].
GovernmentofPakistan toprovide
subsidy totheconsumershasparticularly kerosene
targeted and
diesel details
[for seeMalik(2007)].
5Petroleum levy(PDL)is a significant
development contributor
toindirect
taxesinPakistan,
andthe
governmenthasmadeadjustments inPDLnumerous timestoabsorbtheimpactofincrease
ininternational
price.

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 Crude
OilPrice, andOutput
Policy
Monetary 429

This studyinspiredby the modelused in Hsing (2005, 2006, 2007, 2008) (with
some modifications)will examinethe impactof crudeoil pricefluctuations on output
growth forPakistanbased on an IS
openeconomy function, an extendedmonetarypolicy
rule (MP) Romer (2006) model and the Taylor rule (2001) and augmentedPhillips
curve,6includingreal effectiveexchangerateand oil pricesas exogenousvariables.In
addition,giventhePakistan'seconomicconditions totaloutstandingdebtandrealforeign
exchange reservesare also includedas variables.
control The macroeconomic modelto
be estimatedforPakistanis specifiedas:

Y=f(YJ,G,R,Sj,Op,D,F) (1)
/=/(7i-a,y-M-5,/*) (2)
n = Jte
+ UY- p) - 0 £ + pOp) (3)
where
Y= Real GDP
/= Real interest
rate
G= Real Government spending
R= Real Government Revenue
S= Real stockprice
D= Real TotalDebt
E= Real effectiveexchangerate(REER)
Op = Real crudeoil priceperbarrel
F= Real foreignexchangereserves
/*= Real worldinterestrate
71= rate
Inflation
ne= Expectedinflation rate
a= targetinflationrate
P= potentialoutput
8= targetrealeffectiveexchangerate
0, p =
X, positiveparameters
Equation(2) is a monetary
Equation(1) is an open economyIS function, policy
andEquation(3) is an augmented
function, curve.
Phillips Applying the implicit-function
theoremand solvingforthreeunknownsV,/,andn,equilibriumoutputis givenby
Y= F (Op,G, R, S, t, /*,D, F, Jie; a, p, 8, X,0, p) (4)
As therealcrudeoil pricerises,aggregatespending mayormaynotdecline.To check
iftherelationshipbetweenoil pricesandoutputis non-linear, function
a quadratic forthereal
oil pricewillbe used.However,iftherelationship is nonlinearthenwe expectthecoefficient
of thesquared-term to be negative.Withtherisein oil pricesinflation rateis expectedto
increase,CentralBank (thatis theStateBankof Pakistan)is expectedto raiserealinterest
rate,whichwould loweraggregatespending.Further, government deficitis expectedto
increase.The impactofdeficitspending if
is expectedtobe negative crowds-out
deficit public
savingandresourceinflowencourages corruptionandresource outflow[SiddiquiandMalik
6Fordetails
seeHsing
(2005,2006,2007,2008).

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430 Malik
Afia

(2001)]. Rise in thecrudeoil pricehas further aggravated thedebtsituation of thecountry.

Rising current account deficitand a large fiscal
deficitas a consequence risingpriceof
of
crudeoil in theglobalmarket has increased thestockof totaldebtand liabilities in Pakistan
[Malik(2007)] andthis willhave a negative impactonoutput.
At thesame timetheexistenceof foreignexchangereservescan help sustainthe
impactof risingoil pricesthushavinga positiveimpacton output.A higherreal stock
priceis expectedto cause householdsto increaseconsumption spendingbecause of the
wealtheffectandbusinessfirmsto increaseinvestment spending.As an alternative to real
stockpricerealinvestment spending(grosscapitalformation) is used in thisstudyand is
expected to have a positiveeffect on realoutput. Another channel though which oil prices
can inducechangesin real economicactivityis thoughtheexchangerates.Depreciation
ofPakistanirupeesis expectedto havea negativeinfluence on therealeconomicactivity.
The selectionof effective oil pricesis difficultas it has the influenceof price-
controls,highand varyingtaxeson petroleum products,exchangeratefluctuations and
thevariationsin thedomesticconsumerpriceindex[Cunado,et al (2005)]. Most of the
empiricalliterature whichanalysetheeffectof oil priceshocksin different economies
use eithertheworldpriceof crudeoil (in $ US) dividedby theconsumerpriceindexin
theUS [e.g.,Hsing(2007); GounderandBartleet(2007); BurbidgeandHarrison(1984)],
while some studies have used world oil price convertedinto respectivecountry's
currency by meansof themarketexchangerate[Mork,et al (1994); Abeysinghe (2001);
Kumar(2005)]. The maindifference betweenthetwo variablesis thatonlythesecond
one takesintoaccountthedifferences in theoil pricethateach countryfacesdue to its
exchange ratefluctuationsor its inflationlevels.Some of thestudieshave used boththe
variablesin orderto differentiate whether each oil priceshockreflects theworldoil price
evolutionor could be due to otherfactorssuchas exchangeratefluctuations or national
priceindexvariations [Cunado,etal (2005)].
In thispaper,forestimation purposesnominalcrudeoil price is convertedinto
Pakistanicurrencyand deflatedby the domesticconsumerprice index to controlfor
exchangerate fluctuations. For the sake of comparisonreal oil price variablein US
dollarsis also generated. Figure1 showsthemovement of real oil priceexpressedin $
US and in Pakistanirupees,exceptfortheperiod1980-85(wheremaybe as a resultof
highdomesticprices)boththeserieshaveshownthesametrend.
Real GDP is measuredin millionRupeesat the 1999-2000price.Quarterly series
is generated usingthemethodology adoptedbyKemal,et al (2004). Quarterly seriesfor
fiscal spendingand totaloutstanding debt is generatedusingthe Lisman and Sandee
methodology.7 For thequarterly seriesof investment spendingmethodology developed
by Arbyand Batool (2007) is used. The real effective exchangerate(REER) is a trade
weightedexchangerate adjustedfor relativeprices. The real world interestrate is
represented by theUS federalfundsrateminustheinflation ratein theUS. Inflation rate
is thegrowthrateof theconsumerpriceindex,and theexpectedinflation is the lagged
inflationrate. Data is collectedfromInternational FinancialStatisticsand the Asian
DevelopmentBank EconomicIndicatorsforvariousyears.All variablesare used in log
formexceptfortheoil pricevariableand thevariableswithnegativevalues.The sample
selectedforthecurrent analysisrangesfrom1979-80Q1 to 2007-08Q2.
7Citedfrom
Bloem,et al. (2001), National
Quarterly Accounts
Manual- DataSources,
Concepts, and
Compilation, VII,Mechanical
Chapter pp.119-124.
Projections,

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 OilPrice
Crude , Monetary andOutput
Policy 43 1

Fig. 1.
8 Or T400

300

J^j
4 0- , / -2 0 0
j

2 0- -1 0 0
/

0 (lIl|l |Ml
111l|lII1111111111111IIl|llIj11111ll|11111II111111■
11Ml
|III|II1111l|lll 11111111111|l"0
1111111l|l11|IM|
80 85 90 95 00 05
01 03
inUS$and03 indomestic
Note:01 isoilprices currency.

IV. EMPIRICAL RESULTS

Firstof all stationary
of all the variableshave been checked.Accordingto the
Augmented Dickey-Fuller (ADF) testall thevariableshave unitrootsin thelevel form
except forthe butare stationary
expectedinflation, in thefirstdifference
at the5 percent
level(Table 1).

Table 1
UnitRootTest(Augmented Dickey-Fuller)
Level Firstdifference
(i) (ii) (i) 00
GDP -1.63 -2.61 -17.55** -17.49**
Oil PriceinRupees 0.73 -0.46 -9.28** -8.98**
Oil Pricein $ US -1.42 0.003 -9.19** -9.41**
Debt -2.60 -2.68 -17.56** -17.49**
DeficitSpending 2.06 -2.34 -3.43** -3.88**
Reserves -1.25 -2.99 -8.203** -8.18**
Investment
Spending -1.37 -2.33 -5.45** -5.36**
Expected Inflation -4.077** -3.99** -12.96** -12.98**
Interest Rate -1.44 -2.73 -9.72** -9.68**
REER -1.44 -1.09 -9.72** -8.76**
at5 percent
"Significant level.
(i) with
anintercept,
and(ii)withanintercept
andtrend.

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432 Malik
Afia

Accordingto the Johnsoncointegration testallowingfora lineardeterministic

trendin data with interceptand no trendthe null hypothesisof one cointegrating
relationshipbetweenreal outputand therighthand sightvariables(usingoil pricesin
domesticcurrency)cannotbe rejectedat the 5 percentlevel, because the statisticof
392.76 is greaterthanthecriticalvalueof239.24. The sametestwhenappliedfora linear
deterministic trendin data with interceptand trendthe null hypothesisof one
cointegrating relationshipbetweenreal outputand therighthandsightvariablescannot
be rejectedat the5 percentlevel,becausethestatisticof427.73 is greater
thanthecritical
valueof 228.29. Thus,suggesting thattherealoutputandtheexplanatory variableshave
a longrunstablerelationship. Whenoil pricesin$US areused,Johnson cointegratingtest
againconfirms thelongrunstablerelationship betweenreal outputand righthandside
variables.
Equationfouris estimatedusingWhitemethodto correctforheteroscedasticity.
Firstdifference is notusedto avoidthepotentialloss of valuableinformationandobscure
outcomes[Hsing(2007)].
Table 2 presents theresults.Equation1 andEquation2 are estimatedusingtheoil
pricesin domestic currency (Rupees), Equation3 andEquation4 areestimated usingoil

Table 2
ResultsofEstimated EquationsUsingWhiteHeteroskedasticity-Consistent
Standard
Errorsand Covariance,and DependentVariable:Log ofReal GDP
Equation1 Equation2 Equation3 Equation4
Constant 2.984 14.883 3.617 13.808
(1.296) (6.366) (1.748) (5.332)
Op 0.0006 0.0005 0.0277 0.012
(2.209)** (2.485)** (2.638)** (1.520)*
Op2 -0.0000003 -0.0000002 -0.00063 -0.0003
(-2.094)** (-2.588)** (-2.88)** (-2.023)**
Debt -0.574 -0.759 -0.606 -0.703
(-2.032)** (-3.941)** (-2.421)** (-3.384)**
Deficit -0.00002 -0.00002 -0.00002 -0.00001
(-3.019)** (-3.816)** (-3.99)** (-3.626)**
Reserves 0.168 0.149 0.176 0.148
(4.536)** (6.315)** (4.807)** (6.142)**
Investment 0.656 0.371 0.596 0.396
(3.722)** (2.808)** (3.599)** (2.808)**
ExpectedInflation 0.043 0.019 0.043 0.0159
(1.671)** (1.147) (1.791)** (0.900)
InterestRate -0.037 0.0013 -0.028 0.0005
(-2.053)** (0.122) (-1.816)* (0.046)
REER -1.797 -1.574
(-5.288)** (-4.326)**
AdjustedR2 082 091 084 0.90
Note:
Included are92after
observations adjusting
endpoints.
isthe/-statistics.
Valueinparentheses
**Significant or1percent
at5 percent critical
level.
* Significant
at10percentcritical
level.

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 Crude
OilPrice,
Monetary andOutput
Policy 433

pricesin $US. The coefficients of theoil pricevariablein linear(positive)as well as in

square form (negative) have the expectedsigns,thusindicatingthe existenceof non-
linear relationbetween the oil prices and the GDP. In all cases coefficientsare
statisticallysignificant.Nonlinearrelationship indicateswhenthereal crudeoil priceis
relativelysmalland less thanthethreshold level,realoutputand realcrudeoil pricehave
a positiverelationship whereaswhentherealcrudeoil priceis relatively highand above
thethreshold level,therelationship becomesnegative.
Based on theestimated equations,thethreshold levelof crudeoil priceis foundto
be 22 ($s/bbl).Thus implying thatwhenever,thepricecrossedthislevel it startshurting
theeconomicoutput.In thesampleperiodit was onlyin 1990s whentheoil priceshave
remainedbelow thatlevel,otherwise theyhaveremainedabove thatlevel.The threshold
level based on theestimatedcoefficients in whichoil pricedata in Pakistanirupeesis
used is 1120 (Rs/bbl).In thesample,frommid 1980s to theend of 1990s,priceshave
remainedbelowthatlevel.
The coefficients of rest of the variableshave expectedsigns, except for the
expectedinflation. Real investment spending(used as a replacement forrealstockprice8)
has a positiveand significant the
impact,supporting findings of theearlierstudiesthat
capitalformation is the main source of economic growth.
Debt variableas expectedhas a negativeand highlysignificant impacton output.
Increaseincrudeoil prices,further worsened thedebtsituation forPakistan(amongthehighly
indebted countries), thushavinga negativeimpacton outputgrowth. Similarly,thenegative
andsignificant coefficientofdeficit spending suggests that the risinggovernment deficitas a
consequence of rise in the international price of crude oil in recent yearsmay not help
stimulate theeconomyand thatfiscaldisciplinewouldbe needed.As discussedin Malik
(2007) thegovernment introduced a PriceDifferential Claim(PDC) on August16,2004,the
objectivewastoreimburse oil companies forthesubsidytoconsumers, thushavinga negative
impacton government exchequer.Secondly, oil and gas sector together accountsfora
significantshare of government revenues. Taxes on petroleum productsare thelargestsource
ofindirect taxrevenuesinPakistan. Withtherisein globaloil pricesgovernment adjustedits
petroleum development levy(majorsourceofindirect taxes)thushavinga negative impacton
totalrevenues.
Foreignexchangereservesas expectedperformed extremelywell. Positiveand
highlysignificant variable suggests the existence of large foreignexchangereserves
the
undermining negativeimpact rising of crude oil prices. Pakistanhas witnessed
phenomenal annual growthrateof around8 percentpriorto 2007-08,itcan be attributed
(althoughpartly)to thelargeinflowof foreignexchangereservesafter9/11.Billionsof
dollarscamein US aid to fightIslamicextremism, besidesprivatetransfers.
The difference betweenEquation1 andEquation2 andbetween3 and4 is thereal
effective exchangerate(REER). Its presencein Equation2 and in Equation4 has an
on
impact thesignificance of worldinterest rateandexpectedinflation (as coefficientsof
bothvariablesbecomeinsignificant). Itselfthecoefficient of REER has as expectedthe
negativesignand is statistically significant. Negativesignof REER indicates,in case of
depreciation of Pakistanirupeesthe adverseimpactson importpricesand otherareas
outweighthepositivebenefits ofexportsthushavinga negativeimpacton output.
sRealstock doesnotperform
price wellintheestimated
equation.

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434 Malik
Afia

Negativeand significant effectof real worldinterestratein Equations 1 and 3

suggests as the US Federal Reserve bank has continuedto raise the federalfunds
its
rate, impact on the Pakistan's economyneeds to be monitored.Significantand
positive influence of the expectedinflationin the same two cases could possiblybe
because of the increase in the money supply- expansionarymonetarypolicy
followedby the State Bank of Pakistanpriorto 2006 in orderto boost economic
growth.Governmentof Pakistan in orderto boost economic growthwas pursuing
expansionaryfiscal policy, too much of the developmentexpenditure.Since there
was no growthon the revenueside therefore monetisationof the fiscal deficithad
taken place. As such oil price and consumerprice relationshipappears to be
extremelylimitedor non-existent. Inclusionof REER outweighstheimpactof world
interestrate and inflationmakingthem insignificant.Overall significanceof the
modelalso improvedwiththeinclusionof REER. In otherwords,it can be concluded
thatwhenoil price goes up, exchangerateis a moresignificant channelto influence
theeconomicoutputas comparedto inflation.
Money supplyfunctionas a replacementof monetaryfunctionwas also tried
but the resultswere insignificant. Lagged dependentvariable was also includedto
testthepartialadjustmentmodel. However,it was significantin some cases but not
in all. Furtherits presencedoes nothave any significantimpacton thebehaviourof
restof thevariables.

V. CONCLUSION
In thispaperan attempt is madeto findtheimpactof crudeoil pricesalong with
othermacrovariableson outputusingtheIS, monetary policyand augmentedPhillips
curve for Pakistan.Oil prices and outputare foundto be stronglyrelatedand this
relationship is bell-shaped,thatis, aftera certainlevel increasein oil pricestarthurting
theeconomy.Since thethreshold levelis quitelow giventhecurrent trendin thepriceof
crudeoil; a seriouscommitment on thepartof thegovernment is neededto sustainthis
risingtrend.Although oil pricesarerecedingbutstillarehighforPakistangiventhestate
ofoureconomy.
GDP growthis regardedas thedriverof oil demandbesides its price.It has the
tendency to reducevulnerability as theshareof oil importsdeclineas incomerises.But
thisis possibleonlywhentheGDP is on thepathof sustainableand long termgrowth.
Sustainablegrowthis possiblewhenthereis a growthin thereal sectors(manufacturing
in particular). On thedemandside, focusshouldbe on the investment side. The rising
trendin investment indicatesstronginvestor
activity confidencein theeconomyimplying
improvements in infrastructure,production capacitiesand productivity.This helpedin
sustainingthe process of economic growth.Therefore,it should be the investment
expenditure as themajorcontributor in GDP. In thelastfewyearswhenGDP in Pakistan
showeda growthof aroundsix to eightpercent, it was theconsumption expenditure that
had itsinfluence, wherecreditflowto privatesectorin theformof consumerfinancing
playeda significant role.9

'Expansionary
monetarypolicieshaveprovided to consumption
support growthin thepast.
consumer
Consequently credit
expansionhasbeenstrong,
possibly thedebtservice
raising burdenof
households.

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 Crude
OilPrice, andOutput
Policy
Monetary 435

For thelastso manyyearspolicymakershavereiterated thedemandforsignificant

growth in our exports, but still it has not achieved.Obviouslyit also dependson the
manufacturing growth,which is from
suffering energyshortages besidesotherfactors.
What the literaturehas suggested is that some countries may reduce oil
consumption to balancethecrudeoil priceincreaseand mayreducetotalexpenditure on
oil consumption. But thisis possibleonlywhenotheralternatives are availableand when
thereare seriousefforts towardstheconservation of energy.At one end we are facing
seriousenergyshortages butat theotherendwe arenotsavingavailableenergy.
No doubt,our monetary and fiscalauthorities are workinghardto stabilisethe
economy,butstillmoreefforts are neededto enhancetheoveralleconomicmanagement
oftheeconomy.
Oil price risks can be eased and effectively tackled with the comprehensive
nationalenergypolicythatstressessupplydiversity, energyefficiency, and the use of
renewableenergy.

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