What Does Pakistan Have to Join the Inflation Targeters’ Club—a Royal Flush or a Seven-Deuce Offsuit?

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.