Taylor rule and the macroeconomic performance in Pakistan

Abstract

A near-consensus position in modern macroeconomics is that policy rules have greater advantage over discretion in improving economic performance. For developing countries in particular, simple instrument rules appear to be feasible options as pre-requisites since more sophisticated targeting rules are generally lacking. Using Pakistan's data, this study has attempted to estimate the Taylor rule and use it as monetary policy strategy to simulate the economy. Our results indicate that the State Bank of Pakistan (SBP) has not been following the Taylor rule. In fact, the actual policy has been an extreme deviation from it. On the other hand, counterfactual simulation confirms that macroeconomic performance could have been better in terms of stability of inflation and output, had the Taylor rule been adopted as monetary policy strategy. The study also establishes that further gains are possible if the parameter values of the rule are slightly modified.