VALIDITY OF MCCALLUM RULE IN MONETARY POLICY REACTION FUNCTION: EVIDENCE FROM PAKISTAN.

Abstract

This article empirically analyzes the operational performance of the McCallum rule in Pakistan’s monetary policy framework by applying the auto distributed lag (ARDL) bound testing approach over the period of thirty eight year .The results demonstrate that the positive and significant response of monetary base factor (e.g.as policy instrument) with the potential output, whereas, the negative and significant association with velocity, it indicates that varied monetary base enhance the growth at cost of low inflation rate. Thus, the stable output in case of long run, hence supports the application of McCullum rule by the State Bank of Pakistan (SBP). This study suggests to introduction of additional monetary variable (monetary base) to the rule make it more robust as well as the consistent observe the velocity of monetary base considering the observed volatility of variables during the entire studied period. Furthermore, study shows that change the monetary base according to specified rule could be used as an optimal benchmark for State Bank of Pakistan (SBP) policy decision.