The International Institute for Science, Technology and Education (IISTE)
Abstract
The Taylor rule (1993) focuses only on two objectives: output and inflation. In practice, the central bank’s loss function (especially in developing countries) contains objectives other than these two, like the interest rates smoothing, exchange rate stabilisation, etc. In this study, the monetary policy reaction function has been estimated. We used the variables as: interest rate as monetary policy reaction function as a dependent variable and exchange rate, money supply and inflation as an independent variables of monetary policy objectives in Pakistan. The main hypothesis of the study is the relationship between the variables of monetary policy objectives in Pakistan using the data for the period 1991-2010 for Pakistan. The econometric framework used in the study is that of VECM. The data was checked for stationarity and was found to be integrated of order one I (1) under the Augmented Dickey-fuller (ADF) test. We found that there is negative impact of exchange rate and positive impact of money supply and inflation on interest rate as monetary policy reaction function.Our results suggest a short-run positive relationship between the variables of monetary policy objectives in Pakistan. There is also found an effectiveness of the variables of monetary policy objectives in Pakistan in the long-run
