The Role of Monetary Policy in the Current Environment:Myths and Reflections

In 2023, Pakistan experienced arguably its worst-ever period of stagflation, with growth plummeting and inflation close to all-time highs. In response, monetary policy was tightened considerably, with the policy rate raised to 22 percent and held at that level for one year. This policy was criticized by many in the media. This paper attempts to draw lessons from this episode. It reviews the literature and international experience to evaluate the underlying basis of the criticism. It finds that much of the criticism is based on myths that either reflect outdated thinking or have no empirical basis. Nevertheless, some of the criticism is worth engaging with. Together with the findings of the review, these more informed critiques provide useful guidance for appropriate monetary policy settings under different economic environments. The paper concludes with a discussion of what this guidance could imply for monetary policy settings as the economy stabilizes and inflation comes down.