DefinePK

Abstract

This study has empirically investigated Global Output Gap Hypothesis(GOGH) for Pakistan using annual time series data from 1982 to 2012.Augmented Dickey Fuller (ADF) and Phillips Perron (PP) tests showedthat dependent variable inflation(INF) was I(1) ,whereas, independentvariables domestic output gap(YGAP) and global output gap(GYGAP)were I(0) and I(1) respectively. In this situation, Ordinary LeastSquares (OLS) was not applicable. Because of different orders ofintegration of variables, Engel Granger and Johansen’s approaches ofcointegration were also inapplicable, whereas, AutoregressiveDistributive Lag (ARDL) approach was an appropriate option. TheBounds test results showed existence of long run relationship amongvariables and Error Correction Model (ECM) results reconfirmed longrun relationship because coefficient of lagged ECM term was foundsignificant with negative sign. All relevant diagnostic tests were alsoperformed to check the validity of results. The results indicated thatGYGAP significantly and positively affected inflation in the long runand short run models, however, YGAP appeared with correct sign butinsignificant coefficients thus confirming the existence of GOGH inPakistan. Policy implication of the current study is that monetaryauthorities should target activity directly instead of believing thatstable inflation represents actual output close to its potential level.