In­fla­tion: causes and cure

The Pak Banker - - Editorial - Dr M Yaqub

For the first time in Pak­istan's his­tory, dou­ble digit in­fla­tion has be­come a norm. The of­fi­cial price statis­tics, in­clud­ing GDP de­fla­tor, whole­sale price in­dex and con­sumer price in­dex, showed an av­er­age an­nual rate of in­fla­tion of more than 15 per cent in the last four years but we all know from ex­pe­ri­ence that prices are ris­ing at a much faster rate than what the of­fi­cial statis­tics tell us. In­fla­tion­ary ex­pec­ta­tions seem to have taken root cre­at­ing a mo­men­tum for price in­creases. The coun­try has thus en­tered a vi­cious cir­cle in which ac­tual price pres­sures and in­fla- tionary ex­pec­ta­tions have be­gun to feed each other. The rav­ages of high in­fla­tion are well known and those in­clude deeper in­come in­equal­ity and poverty, fall­ing sav­ing and ris­ing con­sump­tion, wide­spread spec­u­la­tion, hoard­ing and black mar­ket­ing, bal­ance of pay­ment vul­ner­a­bil­ity, so­cial ten­sions and po­lit­i­cal in­sta­bil­ity. Some eco­nomic pol­icy cir­cles blame in­ter­na­tional prices, nat­u­ral dis­as­ters and fac­tors be­yond govern­ment con­trol as the main con­trib­u­tory fac­tors. Such ex­pla­na­tions are meant to con­fuse rather than en­lighten peo­ple about the causes of in­fla­tion in Pak­istan. While world prices and nat­u­ral dis­as­ters do have tem­po­rary in­flu­ence on prices, their weight re­mains lim- ited and im­pact tran­si­tory. In­fla­tion is prin­ci­pally a man­made and home-grown phe­nom­e­non in Pak­istan. Un­less the govern­ment and the State Bank of Pak­istan take full re­spon­si­bil­ity for its causes and con­se­quences, pol­i­cy­mak­ers will con­tinue to de­fer se­ri­ous pol­icy ac­tions to ar­rest the ris­ing trend in prices. A govern­ment that de­pends ex­ces­sively and per­sis­tently on print­ing of notes and in­di­rect taxes to fi­nance its mostly un­pro­duc­tive ex­pen­di­ture and a cen­tral bank that can not re­strict mon­e­tary ex­pan­sion within the lim­its dic­tated by the rate of out­put growth will fail to con­tain in­fla­tion within safe lim­its. If ex­or­bi­tant money cre­ation had not be­come a con­trib­u­tory fac­tor for in­fla­tion, the rate of in­fla­tion would have re­mained in a mod­er­ate range of four to seven per cent per year in Pak­istan. Even such a rise in prices may ap­pear ex­ces­sive, but should be ex­pected in a de­vel­op­ing econ­omy ex­posed to the global en­vi­ron­ment. Pak­istan can ex­pect a two to three per cent an­nual rise in prices due to the process of devel­op­ment it­self that in­volves mo­bil­ity of the fac­tors of pro­duc­tion and struc­tural shifts in pro­duc­tion gen­er­at­ing a rise in over­all prices due to rel­a­tive price ad­just­ments. An­other one to two per­cent rise in prices may rep­re­sent the im­pact of changes in world prices of com­modi­ties that are used and im­ported into Pak­istan. Price re­forms within the coun­try could be re­spon­si­ble for an­other one to two per cent rise in the over­all price in­dex. The high dou­ble digit in­fla­tion be­ing faced by the coun­try rep­re­sents the im­pact of the high rate of money cre­ation re­sult­ing from im­pru­dent fis­cal and mon­e­tary poli­cies. Un­less this fact is recog­nised con­tain­ment of in­fla­tion within a rea­son­able range of four to seven per cent per an­num will re­main elu­sive. Con­tain­ment of money sup­ply within the safe lim­its is the re­spon­si­bil­ity of SBP. For this pur­pose, it was given au­ton­omy in 1997 not only for the reg­u­la­tion of credit to the pri­vate sec­tor but also to set lim­its on govern­ment bor­row­ing from the bank­ing sec­tor and en­force them through the in­stru­ments at its dis­posal. The SBP failed to ex­er­cise the le­gal power given to it in 1997 to con­tain govern­ment bor­row­ings from SBP within safe lim­its, and in fact it gave an open gen­eral li­cense to the govern­ment to en­gage in waste­ful ex­pen­di­tures fi­nanced by print­ing notes by the SBP. A cen­tral bank is cre­ated not to act as a print­ing press for cur­rency notes for the govern­ment but to act as a cus­to­dian of mon­e­tary sta­bil­ity in a coun­try. Ex­ces­sive govern­ment bor­row­ing from the cen­tral bank gen­er­ated high pow­ered money into the bank­ing sys­tem in the form of ex­cess re­serves which could not be dried up by ap­ply­ing brakes on com­mer­cial bank lend­ing to the pri­vate sec- tor and by rais­ing lend­ing rates to the pri­vate sec­tor. In fact, it is not even pru­dent pol­icy to pe­nalise the pri­vate sec­tor by in­creas­ing in­ter­est rates and low­er­ing credit avail­abil­ity to off­set the ex­pan­sion­ary im­pact of an ir­re­spon­si­ble fis­cal pol­icy. That kind of ap­proach only en­cour­aged the govern­ment to be more waste­ful and reck­less in its ex­pen­di­tures. The SBP has to mea­sure up to its crit­i­cal re­spon­si­bil­ity in the fight against in­fla­tion. First, it needs to ap­ply firm brakes on ex­pan­sion in money in the next two to three years to drain out the han­gover of liq­uid­ity cre­ated in the sys­tem by an ex­pan­sion­ary fis­cal and mon­e­tary pol­icy in the last sev­eral years.

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