Do Inflation Expectations Matter for Inflation Forecastability:Evidence from Pakistan

JEL Classification : E31, E37
Publication Year : 2016

We empirically investigate if the incorporation of inflationexpectations helps improve the forecasting performance of a suite ofunivariate inflation models. Since inflation forecasts are instrumentalto the conduct of an effective monetary policy, any possible improvementin the inflation forecastability may tend to enhance the effectivenessof monetary policy—by providing forward guidance both to the monetaryauthority 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 inflationexpectations, whether contemporaneously or with a 6-months lead improvesthe predictive ability—both in-sample and out-of-sample for 6 and12-month horizons. Deterioration however is observed for a 3- monthhorizon, which point towards the weak representation of the expectationsdata for a 3- month horizon. JEL Classification: E31, E37 Keywords:Inflation-expectations, Forecast-performance, Pakistan.

Fayyaz Hussain,

Zafar Hayat