Abstract:
The economic and institutional structure required to successfully adopt
and implement an inflation targeting framework (ITF) is often lacking in
emerging economies. This paper evaluates these structures both qualitatively and
quantitatively for Pakistan’s economy. Although our comprehensive assessment
finds that many of the core requirements remain unrealized, the literature and
real-time experience argue that an ITF remains possible for emerging economies
even in the absence of these conditions. We investigate whether—were the State
Bank of Pakistan to adopt an ITF—there exists a stable and significant
relationship between the policy rate (monetary tool) and inflation measure
(objective). It is important to analyze this bivariate relationship, given the key
role of the interest rate in mitigating deviations between actual and target
inflation when working within an ITF. To illustrate this relationship, we use
Granger Causality test, but our estimates fail to find any significant link between
the interest rate and inflation. On the basis of our overall findings, we suggest
that Pakistan, in the absence of most of the fundamental requirements of an ITF,
is perhaps not yet ready for it.
