Polemics of discount rate adjustment.

Byline: Masood H. Kizilbash

THERE has been acerbic debate during the past few weeks on the discount rate adjustment to zero or a near-zero level in Pakistan to stimulate the sagging economy following coronavirus that has engulfed the whole globe.

The initial response of governments and central banks to Covid-19 was framed on the understanding that the virus was geographically limited to China. Therefore, the application of the classical model of Milton Friedman's theory of 'helicopter money' was thought to be adequate to offset adverse effects on their economies by resorting to monetary expansion to make payments directly to individuals and business houses.

This was considered enough to provide an impetus to the economy by stimulating aggregate demand as this was the recipe that successfully tried to counter the global financial crisis of 2008-09. However, when Covid-19 was declared a pandemic, the monetary model, as adopted initially, could no longer deliver.

The underlying reason is that it is predominantly a supply-side phenomenon. This is best described in an article titled 'Implications of coronavirus' dated March 18, 2020, in The Financial Times Adviser by David Thorpe: 'while the coronavirus pandemic is a problem on a different scale to the European debt crisis (2011), what both events have in common is that they are both supply-side shocks to the economy and demand-side shocks occurring at the same time; something which rarely happens in economics.'

This point was more emphatically made by the Chief Economist of the Bank of England Jeremy Thomas Cook following the reduction of the discount rate to 0.1 per cent on March 19. He said the fresh rate cut takes interest rates to the lowest they can feasibly go and went on to argue that monetary policy has nothing to do with supply-side shocks. It signalled direct intervention by the government through the offer of large chunks of fiscal packages that aimed at fighting the virus and catering to the basic needs of people.

The existing policy framework has become irrelevant to govern an economy the size of Pakistan with its limited structural base

Apart from several packages of support by Dubai and Abu Dhabi governments that aimed at reducing the burden on consumers, the United Arab Emirates government launched a new set of initiatives under 'Ghadan 21' on March 16, which included water and electricity subsidies to citizens, a generous package for small and medium enterprises comprising...