Threshold Effects of Exchange Rates and Monetary Policy on Economic Growth in Pakistan

Abstract

This study examined the threshold effects of exchange rate and M2 money supply on economic growth in Pakistan, using seasonally adjusted quarterly time-series data from 1982-Q1 to 2020-Q4. Hansen’s (2000) threshold regression method was employed to endogenously determine multiple thresholds rather than imposing arbitrary breakpoints. The results confirmed three distinct threshold regimes for each variable. For the exchange rate, the first regime (low exchange rate) showed a significant positive effect on growth, the second regime (medium exchange rate) exhibited a significant negative effect, and the third regime (high exchange rate) revealed an insignificant effect. For the money supply, all three threshold regimes showed positive effects: strongest in the low M2 regime, weakest in the medium regime, and moderate recovery in the high regime. These findings confirm non-linear, regime-dependent effects, implying that the State Bank of Pakistan should calibrate exchange rate and monetary interventions according to prevailing threshold levels to maximize growth impact.