AN ESTIMATION OF MONETARY POLICY REACTION FUNCTION IN PAKISTAN

Abstract

This study has analyzed the monetary policy reaction function of Pakistan's economy. To attain the objective of the estimation of the Taylor rule, we have used quarterly data from 2005q1-2020q3.Static and dynamic rules for the closed and open economy are estimated to investigate the monetary policy reaction function. For this purpose, we have used the OLS technique. We also have investigated the issue of non-linearity of the monetary policy reaction function in terms of the output gap and inflation rate, assuming asymmetric monetary authority preferences. The monetary policy tool has a lot of inertia and the exchange rate highlights fluctuation in interest rate. The State bank of Pakistan does not consider the nominal exchange rate in its monetary policy. In the first rule, we find the consumer price index appears to be significantly positive with average treasury bills and average call money rate but insignificant with an average coupon rate. In the second rule, we find the nominal effective exchange rate insignificant to the average Treasury bill, average coupon rate and average call money rate which shows that the state bank of Pakistan does not consider the nominal exchange rate in its monetary policy. In the third Rule, we find the lag of the average Treasury bill which appears positive and significant with all variables which reflects that the lag of the average Treasury bill has a more powerful impact than other variables to estimate the monetary in Pakistan.