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Re-estimation of Keynesian Model by Considering Critical Events and Multiple Cointegrating Vectors

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  • Hafsa Hina

    (Pakistan Institute of Development Economics (PIDE), Islamabad.)

  • Abdul Qayyum

    (Pakistan Institute of Development Economics (PIDE), Islamabad.)

Abstract

This study employs the Mundell (1963) and Fleming (1962) traditional flow model of exchange rate to examine the long run behaviour of rupee/US $ exchange rate for Pakistan economy over the period 1982:Q1 to 2010:Q2. This study investigates the effect of output levels, interest rates and prices and different shocks on exchange rate. Hylleberg, Engle, Granger, and Yoo (HEGY) (1990) unit root test confirms the presence of non-seasonal unit root and finds no evidence of biannual and annual frequency unit root in the level of series. Johansen and Juselious (1988, 1992) likelihood ratio test indicates three long-run cointegrating vectors. Cointegrating vectors are uniquely identified by imposing structural economic restrictions on purchasing power parity (PPP), uncovered interest parity (UIP) and current account balance. Finally, the short-run dynamic error correction model is estimated on the basis of identified cointegrated vectors. The speed of adjustment coefficient indicates that 17 percent of divergence from long-run equilibrium exchange rate path is being corrected in each quarter. US war with Afghanistan has significant impact on rupee in short run because of high inflows of US aid to Pakistan after 9/11. Finally, the parsimonious short run dynamic error correction model is able to beat the naïve random walk model at out of sample forecasting horizons.

Suggested Citation

  • Hafsa Hina & Abdul Qayyum, 2015. "Re-estimation of Keynesian Model by Considering Critical Events and Multiple Cointegrating Vectors," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 54(2), pages 123-145.
    • Handle: RePEc:pid:journl:v:54:y:2015:i:2:p:123-145
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    References listed on IDEAS

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    2. Muhammad Arshad Khan & Saima Nawaz, 2018. "Does Pak-Rupee Exchange Rate Respond to Monetary Fundamentals? A Structural Analysis," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 57(2), pages 175-202.

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    More about this item

    Keywords

    Exchange Rate Determination; Keynesian Model Out of Sample Forecasting; Random Walk Model;
    All these keywords.

    JEL classification:

    • F31 - International Economics - - International Finance - - - Foreign Exchange
    • F37 - International Economics - - International Finance - - - International Finance Forecasting and Simulation: Models and Applications
    • F47 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Forecasting and Simulation: Models and Applications

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