Abstract:
An optimal monetary policy is crucial for the macroeconomic stability in terms of output and
inflation. A general debate in macroeconomics is that monetary policy rules have a greater
advantage over discretionary stance in order to enhance and improve the economic activity. The
State Bank of Pakistan (SBP) has not ever stated itself to be following any sort of rule. Design of
optimal rule results in complications that cannot be implemented easily. This study explores two
monetary policy rules, namely the price and the quantity rule. For this purpose we have used the
calibration analysis based on DSGE model for Pakistan, using quarterly data from 1992Q3 to
2017 Q2 the parameters of the Taylor rule and the money supply rule have been estimated by
applying GMM technique. Counterfactual experiments by using money supply as a policy
instrument have also been undertaken of the study that the quantity rule raises volatility in output
gap and inflation. On the other hand, volatility in inflation and output gap has been found to be
minimum in the Taylor rule, implying that the price rule outperforms over the money supply rule
and it converges to steady state. This outcome supports the policy stance of the SBP that focuses
on the price of money as a policy rule to control inflation and output variability.
