An Empirical Investigation of the Quantity Theory of Money in Pakistan

Abstract

One of the macroeconomic objective is to have price stability. The quantity theory of money (QTM) explains the nexus between money supply and price level in the economy thus, QTM provides the theoretical framework for monetary policy to bring price stability. Therfore, this study investigates the validity of QTM in Pakistan in time series study. This study applied different econometric techniques, unit root tests, cointegration test, and fully modified ordinary least square (FMOLS) cointegration regression. The variables money supply, price level, interest rate and output are cointegrated in the long run. The results of the FMOLS regression indicate positive and significant effect of money supply on price level henceforth; this study validate the QTM in Pakistan. The study suggests that monetary policy can effectively control the price level in the economy to maintain economic stability and sustain economic growth.