The size of informal economy in Pakistan

This paper estimates the size of informal economy in Pakistan by using monetary approach with some modifications, electricity consumption approach and MIMIC model. Under monetary approach, we take care of the issue of the stationarity of variables and use autoregressive distributed lag (ARDL) model instead of simple OLS and add education as an additional factor affecting the size of informal economy along with some other technical improvements in the standard monetary models. The electricity consumption approach and MIMIC models are used for the first time in case of Pakistan. The results show that the informal economy in Pakistan has been about 30 percent of the total economy which declined considerably in 2000s. Currently, about 20 percent of the economic transactions are taking place in the informal sector.Informal Economy, ARDL, MIMIC

Evaluating Performance of Inflation Forecasting Models of Pakistan

This study compares the forecasting performance of various models of inflation for a developing country estimated over the period of last two decades. Performance is measured at different forecast horizons (up to 24 months ahead) and for different time periods when inflation is low, high and moderate (in the context of Pakistan economy). Performance is considered relative to the best amongst the three usually used forecast evaluation benchmarks – random walk, ARIMA and AR(1) models. We find forecasts from ARDL modeling and certain combinations of point forecasts better than the best benchmark model, the random walk model, as well as structural VAR and Bayesian VAR models for forecasting inflation for Pakistan. For low inflation regime, upper trimmed average of the point forecasts out performs any model based forecasting for short period of time. For longer period, use of an ARDL model is the best choice. For moderate inflation regime different ways to average various models’ point forecasts turn out to be the best for all inflation forecasting horizons. The most important case of high inflation regime was best forecasted by ARDL approach for all the periods up to 24 months ahead. In overall, we can say that forecasting performance of different approaches is state dependent for the case of developing countries, like Pakistan, where inflation is occasionally high and volatile

Evaluating Performance of Inflation Forecasting Models of Pakistan

This study compares the forecasting performance of various models of inflation for a developing country estimated over the period of last two decades. Performance is measured at different forecast horizons (up to 24 months ahead) and for different time periods when inflation is low, high and moderate (in the context of Pakistan economy). Performance is considered relative to the best amongst the three usually used forecast evaluation benchmarks – random walk, ARIMA and AR(1) models. We find forecasts from ARDL modeling and certain combinations of point forecasts better than the best benchmark model, the random walk model, as well as structural VAR and Bayesian VAR models for forecasting inflation for Pakistan. For low inflation regime, upper trimmed average of the point forecasts out performs any model based forecasting for short period of time. For longer period, use of an ARDL model is the best choice. For moderate inflation regime different ways to average various models’ point forecasts turn out to be the best for all inflation forecasting horizons. The most important case of high inflation regime was best forecasted by ARDL approach for all the periods up to 24 months ahead. In overall, we can say that forecasting performance of different approaches is state dependent for the case of developing countries, like Pakistan, where inflation is occasionally high and volatile

The size of informal economy in Pakistan

This paper estimates the size of informal economy in Pakistan by using monetary approach with some modifications, electricity consumption approach and MIMIC model. Under monetary approach, we take care of the issue of the stationarity of variables and use autoregressive distributed lag (ARDL) model instead of simple OLS and add education as an additional factor affecting the size of informal economy along with some other technical improvements in the standard monetary models. The electricity consumption approach and MIMIC models are used for the first time in case of Pakistan. The results show that the informal economy in Pakistan has been about 30 percent of the total economy which declined considerably in 2000s. Currently, about 20 percent of the economic transactions are taking place in the informal sector

Quarterly Bayesian DSGE Model of Pakistan Economy with Informality

In this paper we use the Bayesian methodology to estimate the structural and shocks‟ parameters of the DSGE model in Ahmad et al. (2012). This model includes formal and informal firms both at intermediate and final goods production levels. Households derive utility from leisure, real money balances and consumption. Each household is treated as a unit of labor which is a composite of formal (skilled) and informal (unskilled) labor. The formal (skilled) labor is further divided into types “r” and households have monopoly over each type “r” labor which depends upon degree of education. We go a step further by converting the existing annually calibrated model to quarterly frequency. As a result our impulse response functions have more relevant and realistic policy implications. From the results we do find the shock absorbing role of the informal sector, however, with short term existence. The model estimation diagnostics also confirm robustness and reasonability of the estimation results

Quarterly Bayesian DSGE Model of Pakistan Economy with Informality

In this paper we use the Bayesian methodology to estimate the structural and shocks‟ parameters of the DSGE model in Ahmad et al. (2012). This model includes formal and informal firms both at intermediate and final goods production levels. Households derive utility from leisure, real money balances and consumption. Each household is treated as a unit of labor which is a composite of formal (skilled) and informal (unskilled) labor. The formal (skilled) labor is further divided into types “r” and households have monopoly over each type “r” labor which depends upon degree of education. We go a step further by converting the existing annually calibrated model to quarterly frequency. As a result our impulse response functions have more relevant and realistic policy implications. From the results we do find the shock absorbing role of the informal sector, however, with short term existence. The model estimation diagnostics also confirm robustness and reasonability of the estimation results

Intrinsic Inflation Persistence in a Developing Country

This study estimates degree of intrinsic inflation persistence in Pakistan using aggregate price index, group level price indices, and individual commodity prices. We find no evidence of a unit root in (MoM) inflation at any level, except for house rent. Using monthly data from 1959 to 2011 we find that the estimate of (overall) inflation persistence is 0.16, which is low but significant. During 2001-2011 (overall) inflation persistence is insignificant. Food inflation does not exhibit any persistence during the last decade. However, the degree of persistence is very high (0.80) and significant for core inflation (NFNE), which weakens slightly (to 0.69) when we account for commodities price shock of 2008. At micro level, the estimated degree of inflation persistence for various groups is found to be relatively higher, in almost 60 percent of the cases, compared to corresponding degree of persistence at aggregate level. This may be because in micro analysis we consider only those commodities for which the estimated degree of inflation persistence is significant

Intrinsic Inflation Persistence in a Developing Country

This study estimates degree of intrinsic inflation persistence in Pakistan using aggregate price index, group level price indices, and individual commodity prices. We find no evidence of a unit root in (MoM) inflation at any level, except for house rent. Using monthly data from 1959 to 2011 we find that the estimate of (overall) inflation persistence is 0.16, which is low but significant. During 2001-2011 (overall) inflation persistence is insignificant. Food inflation does not exhibit any persistence during the last decade. However, the degree of persistence is very high (0.80) and significant for core inflation (NFNE), which weakens slightly (to 0.69) when we account for commodities price shock of 2008. At micro level, the estimated degree of inflation persistence for various groups is found to be relatively higher, in almost 60 percent of the cases, compared to corresponding degree of persistence at aggregate level. This may be because in micro analysis we consider only those commodities for which the estimated degree of inflation persistence is significant

Learning from Errors While Forecasting Inflation: A Case for Intercept Correction

Structural changes are quite common in macroeconomic time series. Moreover, any underlying macroeconomic relationship cannot be correctly specified unless we know the true model. Structural changes in time series and misspecification in empirical model are observed as shifts in the constant of the underlying relationship between the subject variables of interest. Forecasting from such a model assuming 'no structural break' and 'correct model' is tantamount to ignoring important aspects of underlying economy and mostly results in forecast failure(s). Intercept correction (IC) is a method for accommodating such ignored structural break(s) and omitted variable(s). We use a simple model (for July 1991 to March 2016) to forecast inflation for 25 countries and compare its performance with a) the same model with optimal IC, b) the same model with half IC, and c) a random walk model. Optimal IC approach, though computational intensive, outperforms in forecasting next period inflation compared to one from a) the same model without IC, b) the same model with half intercept correction, and c) random walk model without IC. For the particular class of inflation models under study, over the time period specified, 'quarter IC' works best among the fixed IC rules

The Size of Informal Economy in Pakistan

This paper estimates the size of informal economy in Pakistan by using monetary approach with some modifications, electricity consumption approach and MIMIC model. Under monetary approach, we take care of the issue of the stationarity of variables and use autoregressive distributed lag (ARDL) model instead of simple OLS and add education as an additional factor affecting the size of informal economy along with some other technical improvements in the standard monetary models. The electricity consumption approach and MIMIC models are used for the first time in case of Pakistan. The results show that the informal economy in Pakistan has been about 30 percent of the total economy which declined considerably in 2000s. Currently, about 20 percent of the economic transactions are taking place in the informal sector. Key Words: Informal Economy, ARDL, MIMIC Acknowledgment We appreciate the comments and feedback given by Ali Choudhary, Moinuddin, Amin Lodhi and participants of a seminar in which this paper was presented.informal economy, Pakistan, South Asia, ARDL, MIMIC