Effectiveness of Monetary Policy: Application of Modified Peter and Clark (PC) Algorithm under Graph-Theoretic Approach
Effectiveness of Monetary Policy: Application of Modified Peter and Clark (PC) Algorithm under Graph-Theoretic Approach

Summary/Abstract: It is common practice that central banks around the world must adopt an inflation targeting framework; based on the assumption that inflation could be reduced by increasing interest rates. This study is first of its kind where we have developed modified Peter and Clark (PC) algorithm to determine the causal nexus between monetary policy and inflation. The results show that, causality is running from interest rate towards inflation; suggesting a positive and significant long-run relationship of interest rate with inflation in case of Pakistan. The results show that, causality is running from interest rate towards inflation; suggesting a positive association of interest rate with inflation in case of Pakistan. Furthermore, both energy prices and monetary policy have cost-side effects on inflation; however, the later becomes counterproductive whenever high interest rate is used to decrease energy push inflation. Hence, there is need of serious rethinking about current monetary policy regime.

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