A structural VAR (SVAR) approach to cost channel of monetary policy

The study aims at investigating, whether or not the cost channel of monetary policy is effective in Pakistan. The cost channel is one of the theoretical justifications of Price Puzzle, a phenomenon that has been observed in a number of empirical studies. Using Structural Vector Autoregression (SVAR) and data from different industries of manufacturing sector of Pakistan over the period 2001:M07-2008:M04, we find strong evidence in favor of Price Puzzle in major industries. In industries like textile, food and beverages, pharmaceuticals, automobiles, and fertilizers, cost channel dominates the traditional demand channel. Same behavior is observed for aggregate price level in the overall manufacturing sector. The main reason for the result is the dependency of the above mentioned industries on short-term borrowing to finance their operational liquidity.