Finance-Growth Nexus and Relative Efficacy of Alternative Policy Regimes: An Investigation for Pakistan

Saira Tufail and Ather Maqsood Ahmed

Abstract

The recurring financial turbulences, witnessed in both advanced and emerging economies over the past few decades, have brought financial stability risks and potential monetary and macro-prudential policies in addressing them, to the forefront of policy debates. This study assesses the nature of finance-growth relationship to address some of the long-standing and recent issues in the conduct of monetary policy. Specifically, it addresses three research questions, that are; 1) Does the traditional finance-growth relationship exist for EDEs? 2) Should benign neglect or lean against the wind be the central bank strategy for stabilizing macroeconomic shocks? and, 3) Does macro-prudential policy present policy dilemma or boosts economic growth by addressing financial vulnerabilities efficiently? By estimating DSGE model using Bayesian technique for Pakistan the findings of the study showed the segregation of financial and business cycle activities and the absence of most trumpeted credit-growth nexus for Pakistan. Given growth is not credit driven, financial instability concerns emanating from credit boom and bust cycles in developed countries become irrelevant for financially less developed EDEs like Pakistan. Price and financial stability goals of central bank are not found dichotomous conforming to Jackson Hole Consensus; a monetary policy strategy prevalent before GFC. Overall findings of study suggest that monetary authority may reconsider its commitment for implementing Basel III and other macro-prudential regulations to counter the risk of over regulation and to boost the process of benign financial deepening.