CAPITAL ACCOUNT LIBERALIZATION, INSTITUTIONAL QUALITY AND INFLATION DYNAMICS: The Case of Pakistan

Abida YOUSAF* and Tahir MUKHTAR**

Price stability is considered an essential component of macroeconomic management of an economy because the higher inflation rate is harmful for various sectors of the country. The main objective of this paper is to investigate the dynamics of inflation in presence of capital account liberalization and the institutional quality variables for Pakistan. The study covers the time period of 1984 to 2015 and employs the ARDL estimation technique to estimate three different specifications based on trade liberalization and the institutional quality measures. The longrun and short-run estimates of different specifications reveal that the model which incorporates the institutional quality measures along with the capital account liberalization index can best explain the inflationary process in. Moreover, growth rate of money supply and the real effective exchange rate are proved significant contributors of inflation; whereas, capital account liberalization, trade openness, per capita GDP and the institutional quality index are helpful in reducing inflation in the country. The study suggest that along with opening of capital account, the government should also ensure stability of institutional quality measures, such as law and order, democratic accountability, transparency and the government stability to control inflation rate in the economy. Furthermore, the policy makers should take proper cautionary measures for controlling growth rate of money supply.