Abstract

Global Financial Crises (GFC) 2007-08 highlighted the importance of incorporating expectations while making economic decisions. The expectations channel of monetary policy transmission mechanism emerged as an important channel than the other channels after the advent of GFC. This study examined the effectiveness of expectations channel of monetary policy transmission mechanism in the case of Pakistan. The monthly data used in this study have been selected from 2012M01 to 2021M12.

The empirical analysis applied in this study used six variables Structural Vector Autoregressive (SVAR) model to lessen the gap between inflation and inflation expectations, then to figure out how macroeconomic indicators feed into the formation of expectations and then to estimate the influence of expectations shocks over the macroeconomic aggregates. This study involves a survey of professional forecasters as well. The results of Impulse Response Functions (IRFs) are supported by the Forecast Error of Variance Decomposition (FEVD) analysis.

The influence of household inflation expectations over the core inflation is explained relatively better than the influence of SBP projections. The responses of monetary policy shocks are more influential than the demand and supply side shocks in the formation of expectations. However, the variations in the macroeconomic aggregates are explained significantly better through SBP projections than inflation expectations of households. Findings backed by empirical analysis further confirm that expectations channel works better via discount rate than via SBP projections in case of Pakistan.