A Relative Comparison of the Local and Foreign Shocks in a Small Open Economy: The Case of Pakistan

Abstract

This study has analyzed the impact of external and trade shocks on the domestic output of Pakistan's economy using the Structural Vector Auto-Regression (SVAR) model with monthly data from 1991 to 2013. The main findings of the study are that although domestic shocks are the primary source of macroeconomic fluctuations in Pakistan, foreign shocks also play a considerable role in explaining the variability in output growth and domestic inflation. Shocks to domestic interest rate and oil price inflation have a notable effect on the growth of domestic output. The impact of foreign output shock on domestic output is not noteworthy. Further, the impacts of oil price inflation and the effective federal funds rate shocks on domestic interest rates are remarkable. The foreign shocks are transmitted to the domestic economy mainly through the trade channel.