<P> There continues to be some debate about whether monetary policy can (or should) smooth business cycles . A central conjecture of Keynesian economics is that the central bank can stimulate aggregate demand in the short run, because a significant number of prices in the economy are fixed in the short run and firms will produce as many goods and services as are demanded (in the long run, however, money is neutral, as in the neoclassical model). However, some economists from the new classical school contend that central banks cannot affect business cycles . </P> <P> Conventional macroeconomic models assume that all agents in an economy are fully rational . A rational agent has clear preferences, models uncertainty via expected values of variables or functions of variables, and always chooses to perform the action with the optimal expected outcome for itself among all feasible actions--they maximize their utility . Monetary policy analysis and decisions hence traditionally rely on this New Classical approach . However, as studied by the field of behavioral economics that takes into account the concept of bounded rationality, people often deviate from the way that these neoclassical theories assume . Humans are generally not able to react fully rational to the world around them--they do not make decisions in the rational way commonly envisioned in standard macroeconomic models . People have time limitations, cognitive biases, care about issues like fairness and equity and follow rules of thumb (heuristics). </P> <P> This has implications for the conduct of monetary policy . Monetary policy is the final outcome of a complex interaction between monetary institutions, central banker preferences and policy rules, and hence human decision - making plays an important role . It is more and more recognized that the standard rational approach does not provide an optimal foundation for monetary policy actions . These models fail to address important human anomalies and behavioral drivers that explain monetary policy decisions . </P> <P> An example of a behavioral bias that characterizes the behavior of central bankers is loss aversion: for every monetary policy choice, losses loom larger than gains, and both are evaluated with respect to the status quo . One result of loss aversion is that when gains and losses are symmetric or nearly so, risk aversion may set in . Loss aversion can be found in multiple contexts in monetary policy . The "hard fought" battle against the Great Inflation, for instance, might cause a bias against policies that risk greater inflation . Another common finding in behavioral studies is that individuals regularly offer estimates of their own ability, competence, or judgments that far exceed an objective assessment: they are overconfident . Central bank policymakers may fall victim to overconfidence in managing the macroeconomy in terms of timing, magnitude, and even the qualitative impact of interventions . Overconfidence can result in actions of the central bank that are either "too little" or "too much". When policymakers believe their actions will have larger effects than objective analysis would indicate, this results in too little intervention . Overconfidence can, for instance, cause problems when relying on interest rates to gauge the stance of monetary policy: low rates might mean that policy is easy, but they could also signal a weak economy . </P>

Which type of monetary policy is followed in pakistan