WHAT should be the goals of our monetary policy? Should it be to maintain price stability or promote growth, or both? It must be both, as universally accepted worldwide, because money and credit influence both inflation and growth. Excessive money results in inflation when growth is close to potential and insufficient credit may constrain growth when it is below potential. This implies that a central bank can promote growth in the short run but as soon as growth nears its potential, excessive money and credit spill over to produce high inflation, rather than increasing output. The relationship between money and growth is for the short term, while that between money and inflation is of a long-term nature.
Should both be given equal priority by a central bank, or should there be more focus on maintaining price stability? While the answer is implicit in the preceding paragraph, before responding more explicitly we should look at how many departments or institutions of government are already focused on promoting growth, and then compare this with the number of institutions focused on containing inflation.
Fears regarding the SBP Amendment Bill, passed by the NA and Senate, are misplaced.
The Planning Commission is responsible for building an “… enterprising and prosperous Pakistan…”. The Finance Division is responsible for putting “…Pakistan on the path of sustained economic development…”. The Ministry of Commerce is responsible for promoting “…Pakistan’s trade interests…”. The Ministry of Communication’s vision is to “accelerate socioeconomic development…”. The Ministry of Industries’ vision is to “to achieve efficient, sustainable and inclusive industrial development”. These quotes are extracted from the latest year books of the respective divisions. This list can be easily enlarged as almost every government department is directly or indirectly involved in promoting growth.
The point here is obvious. The State Bank of Pakistan should be focused on maintaining price stability, besides supporting growth, when so many government departments are already focused on promoting growth, and none on maintaining price stability. Despite this weakness, a simple and rational introduction of price stability as the primary objective of our central bank law is also under fire from several quarters. What is distressing and disquieting is the apprehension that was expressed by some learned, seasoned and experienced economists, academics and analysts on various features of the SBP Amendment Bill passed by the National Assembly recently, and now by the Senate.
All these apprehensions are misplaced, in my view, and mainly stem from the fear of an imaginary central bank perceived to be so irrationally powerful that it will allegedly work against the national interest (an impossible scenario). Once the fear set in, the discourse on State Bank independence tilted towards its unlikely cons, rather than the likely pros. As electronic and social media thrive on overemphasising the negatives, even some top-notch economists have succumbed to this fear. Because many of them are excellent teachers, this fear might be spreading to the students also. An appalling situation, to say the least.
Several other features of amendment have also been criticised severely. One feature critical to achieving price stability is to get rid of excessive printing of money, which requires the government not to borrow directly from the central bank. Our history shows that the State Bank was never able to restrict this lending despite the presence of the clause “… Federal Government borrowing from the Bank shall be such that at the end of each quarter they shall be brought to zero…”. The amendment prohibits the bank from extending direct credit to the government. Surprisingly, many analysts are afraid of this prudent amendment, forgetting that there is no ban on indirect credits to government, which are less inflationary than direct credits.
This restriction will be conducive to achieving ‘price stability’, which has been defined as “the maintenance of low and stable inflation guided by the government’s medium-term inflation target”. An informed discourse on amendments could have been on this definition alone. To my knowledge, no one has raised any objections to this definition, but many have amplified the fear of ignoring the growth goal, forgetting that the central bank will always support growth. A monetary policy framework that ignores growth does not exist anywhere in the world. A flexible inflation-targeting framework appropriately accommodates both inflation and growth targets.
Monetary policy actions of the State Bank will be guided by the inflation target set by the government. What should be the target rate of inflation? Should this be a specific number or a range, and at what level? These are research questions. Some input can be gathered from the research done by the State Bank through its ‘Working Paper Series’ available on its website. Various researchers have estimated a ‘threshold’ level of annual inflation at which growth is maximised. These estimates lie between four and nine per cent. This means that inflation higher than 9pc or lower than 4pc hurts growth. Considering these studies, it would be prudent to set a medium-term inflation target range at 5pc to 8pc per annum. This implies a specific annual numerical target of 6.5pc.
The government’s past targets were not very different, mostly around 7pc or close, while during the past 50 years (FY1972 to 2021) the actual outcome of average annual inflation ranged between 2.9pc to 30pc. Inflation was higher than 7pc in 31 of these 50 years. Average annual inflation during this period was 9.1pc, not a commendable performance. While there are various reasons for this, the lack of clarity in State Bank goals and direct excessive lending by the bank cannot be ruled out as important factors. Clarity in goals may not necessarily ensure better performance, but it is likely to improve it, and not worsen it at least. Those who believe that the objective of containing inflation should not be given precedence over promoting growth should review the global history of inflation. Unhindered growth promotion by a central bank undermines long-term growth and produces high or hyperinflation.
The writer is a former deputy governor of the State Bank of Pakistan.
Published in Dawn, January 29th, 2022