Inflationary dynamics under fiscal and monetary asymmetries: a nonlinear investigation in Pakistan

Amidst the evolving economic landscape of Pakistan, understanding the drivers of inflation is more crucial than ever. This study rigorously examines the asymmetric impacts of exchange rate volatility, fiscal imbalance, and money supply on inflation, aiming to unravel the complex interplay of these key economic variables. Employing a robust Nonlinear Autoregressive Distributed Lag (NARDL) model, the analysis utilizes an annual dataset from 1991 to 2022 to explore both the short-term and long-term effects on inflation. The model’s strength lies in its capacity to capture the nuanced nonlinear relationships and the asymmetric effects of economic shocks. The findings reveal that positive shocks in money supply significantly influence long-term inflation, whereas negative shocks impact short-term inflation dynamics. Similarly, increases in fiscal deficits marginally intensify short-term inflation, but reductions significantly alleviate long-term inflation pressures. Both positive and negative exchange rate shocks are found to adversely affect short-term inflation, with negative impacts persisting in the long term. Additionally, the study confirms bidirectional causality between inflation and economic growth, and identifies a feedback relationship between public spending and inflation, with government expenditures exerting a unidirectional influence on inflation dynamics. These insights underscore the need for refined monetary policies to adeptly manage money supply, emphasizing strategic debt management to balance fiscal activities and promote sustainable growth. Stabilizing exchange rates is also highlighted as essential for protecting the economy from external perturbations. This comprehensive analysis not only advances our understanding of inflationary dynamics in Pakistan but also offers valuable implications for economic policy in similarly structured economies.