Open AccessThe Economics of Inflation, Issues in the Design of Monetary Policy Rule, and Monetary Policy Reaction Function in Pakistan
Author(s) -
Ather Maqsood Ahmed,
Wasim Shahid Malik
Publication year - 2011
Publication title -
the lahore journal of economics
Language(s) - English
Resource type - Journals
eISSN - 1811-5446
pISSN - 1811-5438
DOI - 10.35536/lje.2011.v16.isp.a9
Subject(s) - economics , monetary policy , inflation (cosmology) , monetary economics , taylor rule , currency , exchange rate , depreciation (economics) , inflation targeting , interest rate , macroeconomics , central bank , microeconomics , profit (economics) , physics , capital formation , financial capital , theoretical physics
The objective of this study is to estimate a monetary policy reactionfunction 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 theinflation rate and economic activity in a manner that is consistent with theTaylor (1993) rule, and with the explicit objective of interest rate smoothing andexchange rate management. This policy has remained consistent for most of thesample period, except for the last two years, during which a price hike and themassive depreciation of domestic currency led to a significant change in theparameters of the policy reaction function. We also find evidence of nonlinearityin the reaction function as the response to an inflation rate above 6.4 percent isfound to be more aggressive than that in low inflationary episodes.