An empirical assessment of Pakistan's discretionary monetary policy strategy using novel discretion and inflation bias indicators : a thesis presented in partial fulfilment of the requirements for the degree of Doctor of Philosophy in Economics at Massey University, Manawatu, New Zealand
Although price and output stability have been the major goals of monetary policy, contention remained over their mutual compatibility and substitution for one another. It is challenging for monetary policy makers to maintain a balance between the price and growth objectives. The pursuit of a balance historically has led monetary policy to evolve under many guises. Discretion and commitment are the two popular monetary policy guises advocated for achievement of the twin objectives of inflation and growth. Under commitment, the long-term growth stability is assumed to be achieved via price stability, and therefore the overriding focus is the inflation objective. Under discretion, the achievement of the dual objectives requires sufficient flexibility with the central banker to adjust monetary policy as and when necessary, and as frequently as desired, to maximize monetary policy benefits. This thesis seeks to empirically investigate to what extent Pakistan‘s typical discretionary monetary policy strategy has benefited the economy both in terms of achievement of inflation and growth objectives as well as maintaining a balance between them for a 50-year timeframe. Using a novel discretion assessment approach, new inflation bias indicators and its determinants as well as a new discretion indicator, the thesis demonstrates that Pakistan‘s discretionary monetary policy strategy failed to deliver on its core mandate. Instead, the policy proved to be self-defeating as it produced results contrary to its very purpose. On one side, the State Bank of Pakistan (SBP) exercising its discretion, induced long-term excessive inflationary pressures in the economy and on the other side hindered the real growth than potentially would have been. This failure of the discretionary monetary policy on both the counts of inflation and growth objectives cast nontrivial doubts on its efficacy to fully reap the benefits of price and growth stability. The major findings of the study call for a reorientation of the focus of the SBP towards the inflation objective as against the growth objective. For this transformation to occur, monetary policy must change from the existing discretionary set-up to a commitment-based policy framework. Under such a framework, the SBP will have to commit to a certain low level of inflation and should not renege upon it to help build its credibility and capability to effectively anchor inflation expectations to ensure price stability, and hence growth-stability.