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The Economics of Inflation, Issues in the Design of Monetary Policy Rule, and Monetary Policy Reaction Function in Pakistan

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  • Ather Maqsood Ahmed

    ()
    (National University of Sciences and Technology (Business School), Islamabad, Pakistan.)

  • Wasim Shahid Malik

    ()
    (Quaid-i-Azam University, Islamabad, Pakistan)

Abstract

The objective of this study is to estimate a monetary policy reaction function for Pakistan. To do this, we use data for the period 1992Q4–2010Q2. Our results show that the State Bank of Pakistan reacts to changes in the inflation rate and economic activity in a manner that is consistent with the Taylor (1993) rule, and with the explicit objective of interest rate smoothing and exchange rate management. This policy has remained consistent for most of the sample period, except for the last two years, during which a price hike and the massive depreciation of domestic currency led to a significant change in the parameters of the policy reaction function. We also find evidence of nonlinearity in the reaction function as the response to an inflation rate above 6.4 percent is found to be more aggressive than that in low inflationary episodes.

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Bibliographic Info

Article provided by Department of Economics, The Lahore School of Economics in its journal Lahore Journal of Economics.

Volume (Year): 16 (2011)
Issue (Month): Special Edition (September)
Pages: 213-232

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Handle: RePEc:lje:journl:v:16:y:2011:i:sp:p:213-232

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Related research

Keywords: Inflation; Monetary Policy; Pakistan.;

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  1. Robert J. Barro & David B. Gordon, 1983. "A Positive Theory of Monetary Policy in a Natural-Rate Model," NBER Working Papers 0807, National Bureau of Economic Research, Inc.
  2. John B. Taylor, 1999. "A Historical Analysis of Monetary Policy Rules," NBER Chapters, in: Monetary Policy Rules, pages 319-348 National Bureau of Economic Research, Inc.
  3. Taylor, John B, 2000. "Alternative Views of the Monetary Transmission Mechanism: What Difference Do They Make for Monetary Policy?," Oxford Review of Economic Policy, Oxford University Press, vol. 16(4), pages 60-73, Winter.
  4. Lars E. O. Svensson, 2000. "Open-Economy Inflation Targeting," NBER Working Papers 6545, National Bureau of Economic Research, Inc.
  5. Troy Davig & Eric M. Leeper & Hess Chung, 2005. "Monetary and fiscal policy switching," Research Working Paper RWP 05-12, Federal Reserve Bank of Kansas City.
  6. Laurence Ball, 1998. "Policy Rules for Open Economies," RBA Research Discussion Papers rdp9806, Reserve Bank of Australia.
  7. Wasim Shahid Malik & Ather Maqsood Ahmed, 2010. "Taylor Rule and the Macroeconomic Performance in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 49(1), pages 37-56.
  8. Rodrigo Caputo & Felipe Liendo, 2005. "Monetary Policy, Exchange Rate and Inflation Inertia in Chile: a Structural Approach," Working Papers Central Bank of Chile 352, Central Bank of Chile.
  9. anonymous, 2005. "Monetary policy report to the Congress," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Spr, pages 117-142.
  10. anonymous, 2005. "Monetary policy report to the Congress," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Sum, pages 319-343.
  11. John B. Taylor, 2001. "The Role of the Exchange Rate in Monetary-Policy Rules," American Economic Review, American Economic Association, vol. 91(2), pages 263-267, May.
  12. Arby, Muhammad Farooq, 2008. "Some Issues in the National Income Accounts of Pakistan (Rebasing, Quarterly and Provincial Accounts and Growth Accounting)," MPRA Paper 32048, University Library of Munich, Germany.
  13. anonymous, 2005. "The implementation of monetary policy," Monograph, Board of Governors of the Federal Reserve System (U.S.), number 2005tiom.
  14. anonymous, 2005. "Monetary policy and the economy," Monograph, Board of Governors of the Federal Reserve System (U.S.), number 2005mpat.
  15. Taylor, John B., 1993. "Discretion versus policy rules in practice," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 39(1), pages 195-214, December.
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