Inflation targeting needed to rectify economy.

Byline: AKRAM KHATOON

Pakistan's economy under severe stress in recent years caused by external factors beyond the country's economic managers' control and internal pandemic-related losses, the impact of natural disasters like floods causing devastation to all sectors of the economy and growing political turmoil since last three years has brought down the economic growth to the lowest ebb. Growing external debt and worsening fiscal and trade deficit impacting budgetary position has changed the external world outlook towards Pakistan.

According to Nobel Laureate James Tobin price, financial and macroeconomic stability places a strict joint requirement on budgetary and monetary policy. Central banks must pursue price stabilizing mechanisms in medium and long-term strategies. Fiscal authorities must guarantee debt sustainability, adjusting their policies consistent with the inflation objectives of the central banks.

During the nineties of the last century, industrialized countries and some of the transitional economies recognized 'inflation targeting' as the most effective tool to control inflationary pressure on their economies. Inflation targeting implies achieving price stability through the mechanism of fixing a target normally on an annual basis to bring down inflation to a certain level. However, this is achievable through institutional commitment and arrangements with the understanding that the central bank is accountable for meeting the target.

Prior to that Central Banks had an emphasis on managing money supply and making use of the Exchange Rate Mechanism to control inflation, but despite these regulatory measures, even highly industrialized countries encountered periods of price level flare up very frequently. In reality, it is impracticable for central banks to play their pivotal role of controlling inflation and ensuring a high economic growth rate simultaneously only through conventional tools of regulating money supply through interest rate mechanisms.

Quite a number of emerging market countries/transitional economies like Brazil, Israel, Mexico, Magnolia, Poland and Botswana etc and Thailand alone in South East Asia have started making use of inflation targeting strategies to arrest frequent bubbles in their Consumer Price Index (CPI) and to achieve long-lasting price stability, culminating into sustained high economic growth rate and employment level. In this regard consumer price index is the most common choice. However...