REAL INTEREST RATE PARITY IN PAKISTAN: A COMPARATIVE STUDY
Abstract
The empirical existence of Real Interest Rate Parity between Pakistan and its trading and financial allies is scrutinized in this research paper. It hypothesizes that real interest rates are equal between these economies. The equality of Real interest rate is analysed among Canada, China, France, Germany, Hong Kong, Japan, Korea, Kuwait, Malaysia, Saudi Arabia, United Arab Emirates, UK, USA and Pakistan during the time period of 1972 Q1 to 2012 Q3. After the deregulation and international integration in the real and financial markets the interaction of major economic variables have become increasingly important. Real interest rate differential model is applied for the determination of exchange rate, which is based on real interest rate parity (RIP) theory, a combination of inflationary expectation of flexible-price model and sticky-price model. Panel cointegration and Panel-VAR techniques are used. Results of the techniques are supported the existence of Real Interest Rate Parity. These results are consistent with the earlier studies that tested real interest parity and nominal exchange rate move simultaneously. This study concludes that for achieving a significant role in the international transactions, it is imperative to improve the working of the domestic markets and then move towards the international markets. This research paper also suggests that without the coordination among all policies (monetary, fiscal, trade and exchange rate) consistency among macroeconomics targets is not possible. Paper’s result strongly supported the existence of RIP for the whole sample period.
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