External shocks and the macroeconomic response of small open economy: A structural-VAR approach for Pakistan

Abstract

Objective: This study examines the impact of external economic shocks on the macroeconomic variables of Pakistan. The external economic shocks consist of the world oil prices, productivity and financial conditions of the main trading partners of Pakistan. Methodology: The open economy structural vector autoregressive (SVAR) model is employed with block exogenous assumption. The identification of the SVAR model is done by imposing non-recursive zero restrictions on the contemporaneous interaction of the variables. Results: The results from structural impulse response functions and forecast error variance decomposition reveal that the impact of adverse external shocks is significantly negative on the economy of Pakistan. In addition to this, we find that external variables are more important in accounting the variability in domestic macroeconomic variables. Conclusion: This study concludes that external economic factors are equally important for the macroeconomic performance of small open economy of Pakistan.