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Does inflation bias stabilize real growth? Evidence from Pakistan

Zafar Hayat, Faruk Balli () and Muhammad Rehman

Journal of Policy Modeling, 2018, vol. 40, issue 6, 1083-1103

Abstract: The motive of a typical discretionary central banker to accommodate excess inflation (inflation bias) is either to stabilize real growth or to spur it beyond natural rate. To what extent inflation bias helps to materialize this intention warrants empirical investigation. A more direct empirical probe into this issue, however, requires observable inflation bias indicators, which we model through desirable and threshold inflation rates as well as their respective society’s preferences. While examining the effects of inflation bias for a typical case of the discretionary monetary policy strategy of Pakistan, we found that contrary to the desired boost/stabilization in real growth, the policy (via. inflation bias) produced counterproductive results. Inflation bias was not merely ineffective in inducing real growth but significantly destabilized it. Moreover, the results, which are robust to different inflation bias indicators and subsample analysis, indicate that the higher the inflation bias, the higher is the intensity (magnitude) of its destabilizing effect and vice versa. This suggests that a policy that would minimize/constrain inflation bias would be a better choice as it would not only help achieve low and stable inflation but also a sustainable real economic growth.

Keywords: Inflation bias indicators; Desirable and threshold inflation; Inflation bias–growth nexus; ARDL; Pakistan (search for similar items in EconPapers)
JEL-codes: E31 E52 E58 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.jpolmod.2018.08.003

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