Adopting Inflation Targeting in Pakistan

Abstract

The objective of this paper is to assess the conditions for inflation targeting in Pakistan. The recent inflationary surge in Pakistan calls for rethinking monetary policy afresh. This paper argues the case for inflation targeting in Pakistan as a policy option to achieve price stability. The country experienced an inflation rate of just below 10 percent during 1970-2009, which makes it a potential candidate for inflation targeting. Applying the VAR technique to data for the same period, inflation is shown to be adaptive in nature, leading us to reject the accelerationist hypothesis. The Lucas critique holds as people are found to use forward-looking models in forming expectations about inflation. The paper also sheds some light on the State Bank of Pakistan’s level of preparedness for the possibility of adopting inflation targeting, for which transparency and autonomy are prerequisites. The interest rate channel can play the role of a nominal anchor in the long run.