Revisiting the macroeconomic variables and economic growth nexus: A Markov regime-switching approach

Abstract

Purpose ―Current paper assesses the impact of macroeconomic variables on Pakistan's economic growth. Method ― This study analyzed the data using the Markov Regime switching (MS) model using monthly data for 1981-2020. Firstly, BDS and CUSUM square tests were applied to detect the non-linearity of the model. Results ―The model is non-linear, so the Markov regime-switching model is used for analysis. Each regime's mean and variance are highly significant and show a high growth regime with high volatility and a low growth regime with low volatility. Furthermore, the results show that inflation, interest rate, and trade openness negatively impact while real effective exchange rates positively affect development in both regimes. The negative effect of interest rate, exchange rate, inflation, and trade openness become more pronounced in low growth regimes. Implication ― This study suggests that policymakers should consider the non-linear behaviour of macroeconomics. This will help to formulate better policies for the economy's economic growth. Originality ―The current research adds to the existing literature by identifying the non-linear effect of growth indicators on economic growth, which was previously neglected in the case of Pakistan.