REAL EFFECTIVE EXCHANGE RATE DYNAMICS AND MACROECONOMIC STABILITY: A COMPARATIVE TIME-SERIES ANALYSIS OF PAKISTAN AND THE USA

Abstract

This study examines the dynamic relationship between real effective exchange rate (REER) fluctuations and macroeconomic stability indicators—comprising current account balance, inflation, GDP growth, and trade openness—for Pakistan and the United States over the period 2001–2024. Beyond its econometric scope, the paper situates exchange rate governance within a broader political economy framework, recognising that REER misalignments are not merely technical phenomena but are shaped by state capacity, geopolitical positioning, civil-military relations, and the asymmetric power dynamics of the international monetary order. Employing an Autoregressive Distributed Lag (ARDL) framework adapted to a comparative panel setting and augmented by Error Correction Model (ECM) estimation, the analysis draws upon annual World Bank World Development Indicators data. Descriptive statistics reveal that Pakistan's REER is considerably more volatile (SD = 7.32) than that of the United States (SD = 10.61), with the latter exhibiting a persistent upward trajectory especially post-2014. Augmented Dickey-Fuller (ADF) unit root tests confirm non-stationarity of all variables at levels, justifying the ARDL-ECM approach. Long-run OLS regression results indicate that inflation exerts a statistically significant negative effect on Pakistan's REER (β = −0.495, p = 0.098), while for the United States, the current account balance (β = 2.434, p = 0.037), inflation (β = 3.553, p = 0.003), and trade openness (β = −3.577, p < 0.001) are highly significant long-run determinants. Error correction terms (ECT) are negative and statistically significant for Pakistan (ECT = −0.455, p = 0.047), confirming long-run convergence at approximately 45.5% per annum. The findings underscore the need for institutional reforms, democratic fiscal governance, and a rebalancing of Pakistan's geopolitical dependencies to achieve durable exchange rate stability. Policy implications are derived for the State Bank of Pakistan (SBP) and the Federal Reserve, respectively, emphasizing inflation targeting, current account management, and trade competitiveness strategies.