Abstract
Traditional macroeconomic theories establish relationship among certain macroeconomic variables based on assumptions of perfect competition and resulting flexible prices. Theories based on these assumptions might not hold for developing economies due to imperfect market structure and fragile financial institutions. This study attempts to analyze the quantity theory of money (QTM) and Phillips curve (PC) relationship from long-run perspective for economy of Pakistan. QTM relates complete absorption of money growth effect into inflation, and PC establishes negative relationship between inflation and unemployment. In the long-run, money is assumed to have only inflationary or nominal effect. Therefore, presence of any long-run tradeoff between inflation and unemployment, once inflations is a pure monetary phenomenon in the long-run, cast serious doubts regarding long-run neutrality of money. Autoregressive distributed lag (ARDL) modelling approach is opted to analyze long-run impact of money growth on inflation, and long-run effect of inflation on unemployment. The long-run relationship between inflation and unemployment is statistically insignificant for economy of Pakistan. Furthermore, results of this study show that inflation, even in the long-run, does not adjust as theorized in QTM.
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