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There is constant debate between Classical and Keynesian on the issue of the flexibility of wages and prices. Classical economists assume flexible wages and prices and Keysian argue for rigid wages and prices. According to Keynesian macroeconomic models, effectiveness of the policy is mainly due to rigid prices. The effectiveness of monetary policy depends on the nature of price adjustment. In Pakistan there is no precise study available on the topic of price rigidity. Within this context, this thesis sets six objectives using the data of disaggregated consumer price index for the period of July 1991 to March 2016. First objective is to explore the price rigidity in Pakistan by using Frequency and Duration of price change. Second objective is to find out the size of last price change. Third objective is to determine the price setting strategy and its determinants for Pakistan by using the Panel Logit Random Effect Model. Fourth and Fifth objectives are to investigate the exchange rate and oil price pass-through using the recursive VAR approach. Sixth objective of the thesis is to check the exchange rate and oil price pass-through asymmetric behavior to disaggregated CPI inflation. The study concludes that prices are flexible but not fully flexible in Pakistan. Prices are more flexible in food items and rigidity is found in communication, education, and health sectors. Hotel, Food and Transport are high inflation category products and Communication, Health, Recreation & Culture are low inflation category groups. Keynes theory verifies that prices are downward rigid and upward flexible for Pakistan. In Pakistan combination of time-dependent and state-dependent policy is used for price setting. Exchange rate and oil pass-through have moderate effect on CPI inflation in Pakistan but their effect remains for twelve months. Exchange rate pass-through is low in flexible exchange rate regime as compared to managed floating exchange rate. Oil price pass-through is more pronounced in volatile period as compared to less volatile period. Domestic oil price pass-through is higher as compare to international oil prices as well as converted international oil prices to CPI inflation. Exchange rate and oil prices have asymmetric pass-through to CPI inflation. Prices in Pakistan are more flexible so State Bank of Pakistan should try to search other transmission mechanisms through which monetary policy can have real effects in the Pakistan economy.
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