The study employs Girton and Roper (1977) measure of exchange market pressuresum of exchange rate depreciation and foreign reserves outflow, to examine the interaction between exchange market pressure and monetary variables, viz. domestic credit (Reserve Money) and interest rate. Evidence from impulse response functions suggests that domestic credit has remained the dominant tool of monetary policy for managing exchange market pressure. The increase in domestic credit upon increase in exchange market pressure (during 199198) is imprudent. The result suggests that fiscal needs/growth objective might have dominated the external account considerations during the span. Post 9/11 there is evidence of sterilised intervention in forex market. Interest rate has also weakly served as the tool of monetary policy during the hay days of foreign currency deposits (199198). The finding implies that for interest rate to work as tool of monetary policy vis-a-vis exchange market pressure a reasonable degree of capital mobility is called for.
Exchange Market Pressure and Monetary Policy: Evidence from Pakistan
PIDE Working Papers 2007:31