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

Author

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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.

Suggested Citation

  • Ather Maqsood Ahmed & Wasim Shahid Malik, 2011. "The Economics of Inflation, Issues in the Design of Monetary Policy Rule, and Monetary Policy Reaction Function in Pakistan," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 16(Special E), pages 213-232, September.
  • Handle: RePEc:lje:journl:v:16:y:2011:i:sp:p:213-232
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    References listed on IDEAS

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    1. Barro, Robert J & Gordon, David B, 1983. "A Positive Theory of Monetary Policy in a Natural Rate Model," Journal of Political Economy, University of Chicago Press, vol. 91(4), pages 589-610, August.
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    5. 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.
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    13. 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.
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    Cited by:

    1. Adnan Haider & Musleh ud Din & Ejaz Ghani, 2012. "Monetary Policy, Informality and Business Cycle Fluctuations in a Developing Economy Vulnerable to External Shocks," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 51(4), pages 609-681.
    2. repec:pid:journl:v:55:y:2016:i:3:p:161-190 is not listed on IDEAS

    More about this item

    Keywords

    Inflation; Monetary Policy; Pakistan.;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • P44 - Economic Systems - - Other Economic Systems - - - National Income, Product, and Expenditure; Money; Inflation

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