Determinants of Deviation from Inflation Targets in Pakistan: A Vector Autoregressive Approach

Abstract

State Bank of Pakistan (SBP) has mandate of price stability along with output growth. However, inflation deviation from the announced target is common. Employing impulse response functions and variance decomposition, over the period, 1991Q1-2007Q4,this paper attempts to explain why inflation targets have been missed in Pakistan. The results are indicative that inflation gap responds to shocks in government credit from State Bank, world crude oil price, real effective exchange rate and money supply. The response is more prominent in case of government credit from central bank. On the other hand, variance decomposition analysis suggests that most of the variation in deviation from the target is explained by its own lagged values followed by variation in government loan from central bank.  Keywords: State Bank of Pakistan; Inflation; Real Effective Exchange Rate; Impulse Response; Variance DecompositionJEL Classifications: E0; E23; E31