Do Inflation Expectations Matter for Inflation Forecastability: Evidence from Pakistan

Fayyaz Hussain, Zafar Hayat

Abstract


We empirically investigate if the incorporation of inflation
expectations helps improve the forecasting performance of a suite of
univariate inflation models. Since inflation forecasts are instrumental
to the conduct of an effective monetary policy, any possible improvement
in the inflation forecastability may tend to enhance the effectiveness
of monetary policy—by providing forward guidance both to the monetary
authority and the market to effectively anchor inflation expectations.
Our results are robust across specifications of our baseline models,
sample sizes and forecast horizons. The introduction of inflation
expectations, whether contemporaneously or with a 6-months lead improves
the predictive ability—both in-sample and out-of-sample for 6 and
12-month horizons. Deterioration however is observed for a 3- month
horizon, which point towards the weak representation of the expectations
data for a 3- month horizon. JEL Classification: E31, E37 Keywords:
Inflation-expectations, Forecast-performance, Pakistan.

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DOI: https://doi.org/10.30541/v55i3pp.211-225

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