Inflation Targeting in a Small Emerging Market Economy: The Case of Pakistan

Syed Akbari and Wimal Rankaduwa ()
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Wimal Rankaduwa: University of Prince Edward Island, Charlottetown, PEI Canada

SBP Research Bulletin, 2006, vol. 2, 169-190

Abstract: The success of inflation targeting monetary policy in established market economies has generated interest among monetary policy-makers in smaller emerging market economies to explore the adoption of the same, in order to overcome their current inflationary trends. In recent years, Pakistan has adopted several structural reforms that have enhanced the role of markets in its economy. Fiscal consolidation has also cleared the way for its central bank, the State Bank of Pakistan (SBP), to adopt independent monetary instruments to conduct its monetary policy. Steps towards greater liberalization of foreign exchange rates, greater accountability of commercial bank executives, and towards increased transparency of SBP’s operations are good reasons to explore the feasibility of a market-based monetary policy aimed at achieving its intermediate targets. The present study explores the feasibility of an inflation targeting monetary policy for Pakistan. Based on our econometric analysis and experiences of other emerging market countries, we raise a few issues that deserve policy-makers’ attention while considering the adoption of an inflation targeting monetary policy. These issues include: the weak impact of monetary policy on domestic prices, the impact of import prices on domestic prices, possible wide fluctuations in output growth resulting from frequent and abrupt adjustment of monetary growth rates when the inflation target is missed, and the lagged adjustment of domestic prices. Some light is also shed on the role of governance structure in determining the monetary and fiscal trends in the country.

Date: 2006
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