Do inflation expectations matter for inflation forecastability: Evidence from Pakistan

Abstract

We empirically investigate if the incorporation of inflation expectations helps improve the forecasting performance of a suite of univariate inflation models. Since inflation forecasts are instrumental to the conduct of an effective monetary policy, any possible improvement in the inflation forecastability may tend to enhance the effectiveness of monetary policy-by providing forward guidance both to the monetary authority and the market to effectively anchor inflation expectations. Our results are robust across specifications of our baseline models, sample sizes and forecast horizons. The introduction of inflation expectations, whether contemporaneously or with a 6-months lead improves the predictive ability-both in-sample and out-of-sample for 6 and 12-month horizons. Deterioration however is observed for a 3-month horizon, which point towards the weak representation of the expectations data for a 3-month horizon.