A near-consensus position in modern macroeconomics is that
policy rules have greater advantage over discretion in improving
economic performance. For developing countries in particular, simple
instrument rules appear to be feasible options as pre-requisites since
more sophisticated targeting rules are generally lacking. Using
Pakistan’s data, this study has attempted to estimate the Taylor rule
and use it as monetary policy strategy to simulate the economy. Our
results indicate that the State Bank of Pakistan (SBP) has not been
following the Taylor rule. In fact, the actual policy has been an
extreme deviation from it. On the other hand, counterfactual simulation
confirms that macroeconomic performance could have been better in terms
of stability of inflation and output, had the Taylor rule been adopted
as monetary policy strategy. The study also establishes that further
gains are possible if the parameter values of the rule are slightly
modified. JEL classification: E47, E31, E52 Keywords: Taylor Rule,
Macroeconomic Performance, Counterfactual Simulation