1. PROBLEM BACKGROUND & AIM OF THE STUDYIn this study we have examined the impact of some important macroeconomicvariables on GDP of Pakistan. GDP, economic health of thecountry, is affected by manymacroeconomic factors like inflation, national income, interest rate, exchange rateetc.Following chart shows many ups and downs in the GDP rate of Pakistan during the tenyear period (2002 to 2011). It shows that GDP was encouraged in 2004-06 perhaps becauseof due to economic reforms by the Musharraf government in the year 2000. In the year2005, the World Bank named Pakistan the top reformer in its region and among the top10 reformers globally.Apart from manyreasons behind this consistent growth inGDPduring this period, low rate of inflation is one of them. During this period the rate ofinflation was 7.944% to 7.921% which is very low compared to the current rate of inflation.But, the growth in GDP could not remain stable and nosedived in the year 2008-2009resulting into high rate of unemployment. There were though various reasons behind thisdecrease in the GDP, prime issue was again the steeply risen rising rate of inflation thatsoared to 13% in 2010.Source: Website of State Bank of Pakistan.Accordingly, this study isaimed at tofind out impact ofcertain macro-economicfactors like inflation, interest rate and real exchange rate on GDP of Pakistan and to findthat what steps or measures can be taken by government of Pakistan in order to boosteconomic growth (GDP) of the country bykeeping eyes on these factors. Support wastaken from previous studies conducted in this regard. For instance, Cecchetti (2000)concluded in his respective study that inflation possesses negative relationship with GDPwhile Levy-Yeyati and Sturzenegger, F. (2002) (2002) found that exchange-rate regimeaffects growth. They said that a linkage between the exchange rate regime and economicgrowth exists but the sign of the influence over each is notclear.Workof Obamuyi (2009)is significant regarding identification of effect of interest rate over the national growth.The results imply that the behavior of interest rate is important for economic growth inview of the relationships between interest rates and investment on one hand and investmentand growth on the other. Studies show that there exists also aunique long-run relationshipbetween economic growth and its determinants, including interest rate.This paper consists of six sections. In section 2 various relevant studies arereviewed. In section 3 research methodology of the paper is discussed which comprisesof description of econometric model, measurement ofvariables used, the datasources,and the econometric techniques used for this study. The results of the empirical investigationare shown in section 4. Section 5 consists of critical debate while the conclusions aredrawn and recommendations suggested in section 6.66Vol. 6, No. 2,(Fall 2010)Exploring Impactof Macro Economic Variables on GDPof PakistanGDP and InflationVarious research studies have been carried out in order to find the relationshipbetweeninflationandcountry'sgrowth.Theissuehascomeintoexistencebetweenstructuralist and monetarists in the year 1950s. Structuralists see inflation having a positiverole in economic growth while in the eyes of monetarists inflation affects the economicprogressnegatively.Forinstance,worksofMallik&Choudhry(2001)andBruno&Easterly (1998) are those works which see inflation harmful to the economic growth ofa country. Findings of these works verified the results of Dornbush (1993) who hadconcluded that there are extreme values which affect the relationship between economicgrowth and inflation. By extreme values he meant either there exist very high rate ofinflation or very low rate of inflation.Thus, Bruno and Easterly (1998) examined only cases of separate high-inflationwith a critical value of 40 per cent and above. They analyzed and concluded that economicgrowth of any country decreases gravely during high inflation and then getbetter immediatelywhen there is decrease in inflation. Inflation does not only matter to individuals but itcreates difficulties and problems in the whole sector of the economy of a country. DeGregorio (1993) and Barro (1995) also verified the negative relation between economicgrowth and inflation. In a similar study of Smyth(1992, 1994, 1995) it was concludedthat an increase of one percent ininflation may cause reduction in growth rate by 0.223%.This relationship is negative but insignificant at low rates of inflation; while inflation athigher rate has a significantly negative effect on economic growth. Blejer (2000) andQayyum (2006) also reached similar conclusions that with the unrelenting high inflationin economy, economic growth of any country suffers and government faces difficultiesin running policies smoothly.Besides reduction in the economic growth, inflation also promotes uncertaintyin economy of the country. Due to this risky nature ofinflation, central banks over theworld have expanded the idea of prime stability and declared it as a major function ofmonetary policy of the country. Blejer (2000) and Qayyum (2006)also say that monetarypoliciesof thecountryneed to betakencare of since major reason ofhigh inflationinPakistan is loose monetary policy or in otherwords excess supply of money growth. Theyfurther recommended that Stated Bank of Pakistan should adopted tight monetary policyfor low inflation rate. In an article Friedman (1963) wrote about the pricestability andstated that the central bank of any country is responsible for this. However, It is disputedthat tight monetary control for a longer period of time can decrease high inflation rates.As Goldstein (2002) remarked that a step to over accelerate theeconomy, through expansionin money circulation or by the currency devaluation will give rise to high inflation ratebut does not boost the economy.Accordingly, we assume:H1= There is statically negative significant impact of inflation on GDPGDP and Interest Rate:The relationship between real rate of interest and economic growth is examinedby Fry, (1995) and Galbis(1995)whoconcluded thatthereis positiveandsignificantrelationship between real rate of interestand the economic growth.According to a studyconducted by WorldBank in 1993, the real interest rate was found having significant anda positive impact on growth of the economy in the absence of inflation because wheninflation is included, the coefficient on interest ratedoes not showsignificant relationship.De Gregorio and Guidotti (1995) concluded that verylow value of realinterest rate causesfinancial disturbance in theeconomy that in turn reduces economic growth. Hence, wepropose:H2= There is statically significantimpact of interest rate onGDP3. METHODThis is cause and effect relationship based study wherein GDP (Gross DomesticProduct) is the dependent variable while inflation, rate of interest and real exchange rateare the independent variables.GDP =1+2Exchange rate +3Interest rate +4Inflation + Where:GDP (gross domestic product) indicates the sumof goods and servicesproducedin the country inone year.Inflation shows a consistent rise in price level. In this study, CPI (consumer priceindex) of Pakistan is taken as measure of inflation.Rate of interest is taken as the real one that is the lending interest rate adjustedfor inflation.Real Effective Exchange rate is used to determinean individual country's currencyvalue relative to the other major currencies in the index, as adjusted for the effectsof inflation. All currencies within the said index are the major currencies beingtraded today: U.S. dollar, Japanese yen, Euro etc.Source of DataThis research is secondary and time series data based. Thestudy is long termanalysis as 32 years data for the period of1980-2011 was used for this study.The datawas collected from the hand book of statistics of State Bank of Pakistan and website ofWorld Bank. The data isarranged in the Table 1 below:Data of macro-economic variables for the period 1980-2011Sources: Website of World Bank and State Bank of Pakistan.3.2 EconometricTechniquesIn order to examine relationship between inflation, exchanges rate, interest rateand GDP regression analysis was undertaken. Multivariate regression test was run for thatpurposewhich showed theeffects ofinterestrate, exchange rate, inflationon country'soutput or GDP.69JournalofManagementandSocialSciencesSidrat Jilani, Farooq-E-Azam Cheema, Muhammad AsimS. No1234567891011121314151617181920212223242526272829303132Years19801981198219831984198519861987198819891990199119921993199419951996199719981999200020012002200320042005200620072008200920102011Interest Rate-1.40-5.25-1.644.440.823.432.952.700.01-4.090.76-5.56-3.16-0.12-1.93-2.830.511.144.431.964.934.623.201.11-2.72-5.60-0.050.49-2.510.54-0.420.22Real EffectiveExchangeRate209.47237.07217.18209.77214.21200.05165.06145.98141.52132.59125.39122.80120.66119.19118.35117.59114.47116.03113.77106.02106.6097.54101.0497.8797.09100.00102.84101.5697.7498.39103.39101.55GDP(annualgrowth rate)10.227.926.546.785.077.595.506.457.634.964.465.067.711.763.744.964.851.012.553.664.261.983.224.857.377.676.185.681.603.604.142.40InflationRate11.9411.885.906.366.095.613.514.688.847.849.0511.799.519.9712.3712.3410.3711.386.234.144.373.153.292.917.449.067.927.6020.2913.6513.8813.90Years

1980