A critique on Pakistan's Monetary Policy.

Byline: Dr Kamal Monnoo

Regardless of who is to be blamed the reality is that economy is in a mess! Economic activity has shrunk dramatically (I can quote from a reliable source that till July 10th, not a single bag of yarn was traded in the Faisalabad yarn market, the largest in the country); exports are consistently declining; Stock Market stands eroded; and investment (both domestic and foreign) is virtually absent. TV talk shows aside, the concern to an average bread winner is not what happened in the past, but what really does the future hold. And it is in this backdrop that the Governor State Bank held a press conference last week to assure the markets that the worst may be behind us, as the economy may in fact grow at a faster pace (3.2-3.3%) than originally anticipated or (more appropriately) indicated by the IMF (2.3-2.4%) and that we may have seen the last of interest rate hikes and Rupee devaluations, or, at least for now. Ironically, he was explaining this while announcing an interest rate hike of 100 basis points!

The real dilemma or challenge facing this government though is that the Pakistani economy may have well and truly entered 'Stagflation' - A phenomenon outlining an economic condition combining slow growth and relatively high unemployment with rising prices, or inflation. One believes that not only are the present economic managers cognizant of this situation, but also that the recent central bank measures largely comprise of actions, which are traditionally used to control stagflation. Taking the textbook monetarist view, the Governor State Bank, seems to have set his primary macroeconomic objective as reduction of inflation, even if this causes higher unemployment and lower economic growth in the short-term. By keeping the discount rate at such a high level (and still with a projected upward trajectory) his underlying argument being that unemployment is a 'price worth paying' for containing higher inflation - in essence the central bank prefers to prefer deflationary/contraction policies to get rid of inflation. The intentions may be noble, however, it may not be so simple. Monetary policy in essence controls inflation through increases in interest rates, in-turn increasing the cost of borrowing and reducing aggregate demand. Now this may or may not work well in reducing inflation in an economy suffering from stagflation, but one thing is for sure that the tool of aggressive discount-rate increases invariably cause a...

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