DYNAMIC CONNECTEDNESS; NETWORK SPILLOVERS; MACROECONOMIC INDICATORS; INFLATION; FOREIGN DIRECT INVESTMENT; ECONOMIC GROWTH; PAKISTAN

Abstract

Understanding the interaction among major macroeconomic indicators has become increasingly important for emerging economies facing inflationary pressures, volatile capital flows, and uneven growth performance. Pakistan offers a relevant case due to recurring episodes of price instability, fluctuating foreign investment, external financing stress, and changing economic growth patterns. In this context, the present study examines the dynamic network connectedness among core macroeconomic variables in Pakistan, with particular focus on inflation, foreign direct investment (FDI), and economic growth (GDP). Using annual time-series data from 1974-2024, the present research uses the Diebold-Yilmaz connectedness framework using variance decomposition of forecast errors. The technique allows deterministic connectedness, pairwise spillovers and net transmitter or receiver roles of the variables. Unlike traditional regression-based analysis, the use of connectedness framework offers a comprehensive view of the transmission of shocks among all the variables over time. The results of the empirical analysis show a moderate but economically significant level of connectedness between inflation, FDI and GDP in Pakistan. GDP turns out to be a large net transmitter of shocks, suggesting that fluctuations in economic output have a broad impact on the inflation rate and the level of investment. Inflation appears to be largely a net receiver, suggesting that local inflation is significantly influenced by changes in growth and foreign investment. The results also show FDI having a dual role as both a transmitter and a receiver, in different macroeconomic conditions. The findings also show that the effect of connectedness is more pronounced in crisis and uncertainty periods, such as global financial pressures, currency crises, and the COVID-19 pandemic. This research adds to the connectedness literature by offering new evidence from an emerging economy where the use of such tools is scarce. The results have policy relevance for policymakers to ensure price stability, sustainable foreign investment and macro-economic growth via effective macro-economic policy coordination.