1 |Effect of Money supply on economic Growth: An empirical study of

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Effect of Money supply on economic Growth: An empirical study of Pakistan

University of Turbat

Project Title: Effect of Money supply on economic Growth: An empirical

study of Pakistan.
Submitted by: Ajmal Khan, Shah jan Inayat,Pullan Faqeer, Wahaj

Submitted to Sir Meer jan

Department of Economics

University of Turbat

Session; 2020/23
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Table of Contents
Abstract_____________________________________________________________________________ 3

1. Introduction________________________________________________________________________4

1.1 The monetarist theory_______________________________________________________________4

1.2 Liquidity Preference Theory__________________________________________________________5

2. Methodology ______________________________________________________________________6

3. Pre-test and Main Results____________________________________________________________ 7

3.1 Unit root test______________________________________________________________________7

3.2 least squares Test__________________________________________________________________8

4. Diagnostic Test_____________________________________________________________________9

4.1 Autocorrelation ___________________________________________________________________9

4.2 Heteroscedasticity test ______________________________________________________________9

4.3 Functional form test________________________________________________________________9

4.4 Parameter stability________________________________________________________________10

5. Conclusion and Policy Implication____________________________________________________11

6. References_______________________________________________________________________12
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Abstract
The effect of money supply in enhancing economic growth in Pakistan investigated in this
study. The major objective of the study is to establish influence of money supply on economic
growth in Pakistan. The study employs data from 1960 to 2021. The data was obtained from the
World development bank Annual report. The data is analyzed using lest squares method test to
check the short causality between broad Money supply and GDP growth in Pakistan and the results
of lest squares test revealed that broad money supply has positive significant effect on GDP growth
and statically significant at 5 percent level. The policy implication was that any short run
fluctuation in country’s broad money supply level by monetary policy officials will bring a
significant positive impact on GDP growth on short run.
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Introduction
The monetarist theory
Friedman(1968) pioneered the monetarist theory which emphasizes that money supply
is a key macroeconomic component that impacts on economic growth of a nation. The monetarist
theory states that changes in the money supply are the most essential determining factor of the rate
of economic growth and the behavior of the business progression (Kenton, 2018). Monetarism
hypothesizes that money supply is the key driver of economic growth which implies that as money
supply rises, people demand more, factories product more and fresh employment opportunitie
emerge (Kimberly, 2018). The promoters of this theory have contended that money has substantial
effect on price level in an economy in the long run while in the short run, it influences employment
and output (Ahuja, 2011). The monetarists consider that the size of the money supply is more
significant than any other factor affecting the economy. They also advocates that monetary policies
are more effective than fiscal policies which include taxation, government expenditure, and debts.
Their support for monetary policy is based on the fact that, they appreciate the role of the Central
Banks of countries in determining money supply in an economy thereby making them more
influential than the government (Kimberly, 2018). According to Khabo (2002) there is a direct
link between monetary sector and the real economic sector. The implication is that the Central
Banks of nations can exert so much influence on economic growth rate since the monetary policy
tools including money supply is under their control. Therefore, if a nation’s money supply
increases, economic activities will also increase and vice versa.

The monetarist theory formula is

: MV= PQ

Where:

M =Money Supply

V = Velocity (number of times an average amount is spent per year)

P = Price of goods and services

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Q = Quantity of goods and services

2.2 Liquidity Preference Theory

Keynes (1936) formulated liquidity preference theory which stresses on the liquidity of an
economy as a measure of economic growth. This theory stipulates that the demand for money is
not to borrow money but the desire to remain liquid which goes with a price referred to as interest
rate. Liquidity preference theory associates demand for money with the quantity of money supplied
by the Central Bank in order to maintain economic stability. According to John Maynard Keynes,
the public holds money for transaction, precautionary and speculative purpose. These three reasons
determine the demand for money and its circulation by the Monetary Authorities of nations, in
other words, the absence of these three purposes will make suppress economic growth in a country.
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2.Methodology.
This study uses a causal research design where by exiting and secondary from of data are
employed to examine the causal effect of the dependent variable on the independent variable.
The dependent variable is the GDP while the independent variable is money supply, Gross
Capital formation, Final Consumption expenditure in Pakistan. All data for Pakistan were
obtained from World development bank. The data collected covered a period from 1960 to
2021.
The regression model adopted for the study:

lGDPt = β0 + β1lMSt + β2lGCFt + β3lFCEt+ et

where,

LGDP= Gross domestic products

MS= Money supply
GCF= Gross Capital formation
FCF= Final Consumption expenditure
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3.Pre-test and Main Results

3.1Unit root test (Result of ADF)

INDICATORS LEVEL 1 st DIFFERENCE

INTERCEPT TREND & LEVEL TREND &
INTERCEPT INT

LGDP ------- ---------- st*

LFCE -------- ----------- st*
LGCF -------- ----------- st*
LMS -------- ---------- st*

All above finding shows that all indicators are not stationary at same level. It is observed
that LGDP, LFCE, LGCF, and LMS are stationary at first difference. According to ADF
test, the ARDL technique will be applied to check the co-integration link. So in our
analysis ARDL technique can be used to measure complex nature of indicators.

3.2 least squares test

Dependent Variable: LGDP

Method: Least Squares
Date: 11/14/22 Time: 21:20
Sample (adjusted): 1960 2020
Included observations: 61 after adjustments

Variable Coefficient Std. Error t-Statistic Prob.

C 0.479369 0.086039 5.571553 0.0000

LMS 0.067833 0.039745 1.706731 0.0733
LFCE 0.773840 0.047887 16.15978 0.0000
LGCF 0.156322 0.030116 5.190666 0.0000

R-squared 0.999838 Mean dependent var 27.51577

Adjusted R-squared 0.999830 S.D. dependent var 2.460848
S.E. of regression 0.032129 Akaike info criterion -3.974766
Sum squared resid 0.058841 Schwarz criterion -3.836348
Log likelihood 125.2303 Hannan-Quinn criter. -3.920518
F-statistic 117307.0 Durbin-Watson stat 0.373649
Prob(F-statistic) 0.000000

The table shows the regression of the results of study. The result shows a strong and positive correlation
between money supply and economic growth represented by LGDP. The R squared is 99%.the R-squared
is the coefficient of determination which shows the extent to which all the independent variables
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explain the changes in the dependent variable. The adjusted R-squared shows the calculated value of
the independent variables captured in the model in order to increase the R2. The Durban-Watson
statistic is approximately 0.373649 which indicates absence of autocorrelation in the sample. The F-
statistic 117307.0 with the p-value 0.0000<0.05. this results is statistically significant and shows that the
model is appropriate for the study. In the words, the independent variables collectively influence
economic growth in Pakistan positively and significantly.
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4. Diagnostic Test

4.1 Autocorrelation test

Breusch-Godfrey Serial Correlation LM Test:

F-statistic 0.814825 Prob. F(5,46) 0.5453

Obs*R-squared 4.800353 Prob. Chi-Square(5) 0.4407

Interpreting
Garneting hypothesis
Ho: No serial correlation
HA: Serial correlation
So we accept the null hypothesis because the p-value<F-statistic so there is no serial correlation.

4.2 Heteroscedasticity test

Heteroskedasticity Test: Breusch-Pagan-Godfrey

F-statistic 1.748524 Prob. F(7,51) 0.1186

Obs*R-squared 11.41910 Prob. Chi-Square(7) 0.1214
Scaled explained SS 7.475352 Prob. Chi-Square(7) 0.3811

Interpreting
Garneting hypothesis
Ho: No Heteroscedasticity
HA: Problem of Heteroscedasticity
So we accept the null hypothesis because there is no heteroscedasticity problem mean the p-value<F-
statistic.
4.3 Functional form test
Ramsey RESET Test
Equation: UNTITLED
Specification: LGDP LGDP(-1) LGDP(-2) LGCF LGCF(-1) LMS LFCE
LFCE(-1) C
Omitted Variables: Squares of fitted values

Value df Probability
t-statistic 1.616473 50 0.1123
F-statistic 2.612984 (1, 50) 0.1123

F-test summary:
Mean
Sum of Sq. df Squares
Test SSR 0.000785 1 0.000785
Restricted SSR 0.015806 51 0.000310
Unrestricted SSR 0.015021 50 0.000300
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Interpreting
Garneting hypothesis
Ho: Model is correctly specified
HA: Model is not correctly specified
So we accept the nu hypothesis because the p-value is less then F-statistic. So the model is correctly
specified.

4.5 Parameter stability

30

20

10

-10

-20

-30
70 75 80 85 90 95 00 05 10 15 20

CUSUM 5% Significance

Stability Test We estimate the CUSUM stability test in the autoregressive distributed lags
method (ARDL) to show the stability of the data. Our variables, data are stable because the
cumulative sum of recursive residuals CUSUM graph is within the limits of5% significance level
and cumulative sum of the square of recursive residuals CUSUMSQ graph is also within the limits
of 5% significant.

In the above graph, we check the significance of our model by using the CUSUM test. The
graph shows the result about CUSUM of squares we check the stability of data by applying this
simple technique.
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5. Conclusion and Policy Implication

From all the above discussion it has resulted that monetary policies have a vital role to encourage and to
ensure the growth in an economy. It controls the flow of money to expansionary and contractionary
techniques to increase and decrease the flow of money respectively. It controls the money in both ways
as in recession or depression by different federal organizations or by the central bank of a nation.
Monetary policy is established by the FOMC (the Federal Open Market Committee). It includes members
like the president of five keep back banks and the board of directors of governance of the Federal Reserve
System. They discussed if different issues in eight meetings held in a year and other gatherings as required.
One of the most powerful policymakers was Volcker, along with his followers collectively made up rules
and policies. There are some common goals given by both Monetarists and Keynesians and even now days
the share also suggested to contribute and achieve Economic growth. The rate of Inflation should be zero
(or less than zero approximately ) in an economy. Monetary policy is established by the FOMC (the Federal
Open Market Committee). It includes members like the president of five keep back banks and the board
of directors of governance of the Federal Reserve System. They discussed if different issues in eight
meetings held in a year and in other gatherings required. One of the most powerful policymakers was
Volcker, along with his followers collectively made up rules and policies. There are some common goals
given by both Monetarists and Keynesians and even now days the share also suggested to contribute and
achieve Economic growth.
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6. References

www.World development bank.com

www.pssr.org.pk... A research paper by Farhana Nosheen 1 Hina Ali * 2 Nazia Nasir 3
1. Assistant Professor, Department of Economics, Govt. Associate College for Women Muzafarabad,
Multan, Punjab, Pakistan
2. Assistant professor, Department of Economics, The Women University Multan, Punjab, Pakistan
3. Research Scholar, Department of Economics, The Women University Multan, Punjab, Pakistan
Pakistan Economic and Social Review Volume 53, No. 2 (Winter 2015), pp. 251-268
MONETARY POLICY AND ITS INFLATIONARY PRESSURE IN PAKISTAN by IMRAN SHARIF CHAUDHRY,
RUQUIA ISMAIL FATIMA FAROOQ AND GHULAM MURTAZA*