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
