Empirical Evidence of Fisher Effect in Pakistan

Fisher hypothesis is used as a theoretical framework because it has serious implication in setting up the monetary policy of the country. Johansen co-integration test and error correction model is applied to determine the nature of relationship between the variables. Furthermore, variance decomposition model is used to explain the error correction model and granger causality with in determined the direction of relationship. The results confirm the presence of fisher effect in Pakistan for the period 1980-2010. However, the casual relationship between money supply and inflation indicate that inflation is not only a monetary phenomena and fiscal imbalance and money creation in the economy also playing an important role in increasing the inflation and money supply in the economy.