International Linkages of Inflation‐Output Dynamics: Fresh GVAR Evidence from Pakistan and Its Trading Partners

Abstract

The key purpose of this study is to explore the relationship between inflation and output dynamics in a global macroeconomic framework by utilising time‐series data from Pakistan and thirty‐two trading partners which account for around 95 per cent of foreign trade of Pakistan, over the period 1979Q2–2016Q4. By featuring the GVAR approach, this paper empirically examined the international linkages to account for cross‐country inflationary spillovers. The findings show that both foreign and global variables jointly and significantly matter for the inflation‐output relationship in developing economies, in general and, in particular, in the economy of Pakistan. The findings from general impulse response functions (GIRF) reveal that shocks to the US real output, oil prices and food prices are transmitted and settled quickly, and put forward a significant impact on real GDP and inflation in Pakistan and its trading partner economies. Inflation in Pakistan is driven more strongly by the global changes in oil and food prices than GDP. For monetary policy formulation, the central bank should take into account developments in inflation‐output dynamics of Pakistan's major trading partners.