The Applicability of Quantity Theory of Money in Case of Pakistan: A Time Series Analysis

Abstract

This paper aims at a dynamic investigation of the validity of Quantity Theory of Money, which states that growth in price level is proportionately due to growth in money supply, in case of Pakistan. Annual Data on all the policy variables are taken for the period from 1961 to 2010. Stationarity Analysis is done through unit-root testing, to see that whether the variables are stationary at levels or not. As all the variables included in the study are found to be stationary at levels, Ordinary Least Squares Methodology is used which reveals that Inflation, being statistically significant, is positively dependent upon the growth in money stock, although not proportionately. Moreover, Engle Granger pair wise causality test is applied to see the direction of this causal relationship between money stock growth and the rate of inflation. Results reveal that there exists long-run positive relationship, between these two variables, operating from growth in money stock to the rate of inflation.

Keywords:- Inflation, Money Supply, Gross Domestic Product.