Should Monetary Policy Be Forward-Looking? Evidence From a Developing Economy

Abstract

This paper has investigated the effectiveness of a forecast-based monetary policy for macroeconomic stabilization in a developing country, namely Pakistan. Using a simple New-Keynesian model and a forecast-augmented structural VAR (identified via three different strategies), we have studied the macroeconomic movements from 2009-2018 in the events of supply-side, demand-side, and monetary innovation shocks. We primarily conclude that a forecast-targeting policy demonstrates a superior stabilization performance than one which relies completely on the past information under all shock scenarios, and this advantage of the former over the latter primarily stems from its ability to better handle inflationary rather than real-output fluctuations.