In recent years, central banks have tried to sustain economic stability by pushing real interest rates down into the negative. In effect, however, by becoming cheer leaders for the ‘new’ economy they have tactlessly been aiding big businesses at the expense of the underprivileged who form the majority of every nation.

Central bankers don’t seem to notice that vision-less market de-regulation is propping up the overly profit-centred private sector at the expense of the under-privileged. This is evidenced by the rapid shrinking of the middle class. Ill-conceived monetary policies are making this class pay for the rising profitability of big businesses.

A recent study reveals some baffling truths about South Korea –10th largest economy of the world. Since 1997 the middle class shrank by five per cent and another 3.9 per cent of the population was pushed below the poverty line. Sweeping market deregulation and the stiffer competition that it encouraged prompted large-scale business re-structuring and layoffs. Kim Geum Tae, Welfare Minister until recently, now admits that neo-liberalism had turned the country into a winner-takes-all economy.

The policy of upping interest rates sluggishly and by too little (when over-heating of the economy demanded it badly), and cutting rates rapidly on the first hint of an economic slowdown, was unwise. It encouraged speculation because this response assured speculators of a safety net and a soft landing. Tragically, this policy was followed in spite of major market melt-downs engineered by speculators.

Central banks allowed real interest rates to remain negative to prevent asset-price bubbles from bursting but in the process destroyed the incentive for saving. In many developed countries, particularly the US, saving culture simply evaporated because the Fed showed scant concern for the fact that being continuously short on domestic savings could eventually prove disastrous.

Only in September 2005 did the outgoing Fed Governor admit that the long spell of ‘economic stability’ afforded by low inflation and low interest rates may have encouraged over-spending and inflated price bubbles. Although he is still unsure about their causes, the deficits (balance of trade, balance of payment and current account) the US economy now suffers from Fed’s policy stance.

These developments ring a familiar bell. During the last three years, SBP’s monetary policy resembled the Fed’s. The object of this piece, however, is not to fault the SBP. It is immensely more important to highlight the fact that policy-makers everywhere lack finesse – the art of making difficult decisions tactfully. Instead, they depend on misleading averages that hide the unevenness in distribution of incomes and impact of inflation.

Undoubtedly, monetary policy has its limits; it pursues the macro objectives that governments want to achieve. Until late 1980s, in Pakistan the policy sought fuller employment. Later, when inflation began to soar, the focus shifted to containing supply-demand imbalances. This shift, implemented in the 1990s without caring about its overall impact, was discarded in 2002 in favour of growth whose deceptive colours are painted by FBS-calculated averages.

Since 2002, with interest rates at their historic lows, borrowing and over-spending rather than saving, became pervasive because share-trading and mortgages on inflated house prices provided consumers with unearned purchasing power which they recklessly spent escalating the demand for consumables that rapidly over-heated the economy. Yet, the resistance to accept harsh ground realities continues for the sake of supporting ‘growth’.

Growth performance itself continues to be measured against the rates achieved by regional economies, which is not the reliable yardstick to use because it downgrades the importance of a country’s own potential by focusing economic activity merely on staying in the race that has now been reduced to a deceptive number game. To the discerning, it betrays the visionless approach of the policy-makers.

In a world awash with cheap money and emerging sources of under-priced goods (the best example being China) that help keep conventional inflation at a low level blinds central bankers to the over-heating of their economies. In this scenario, persisting with negative real interest rates encourages over-consumption, over-spending, over-heating of the economy, all pumping up asset-price bubbles.

Asset-price bubbles that central bankers confuse with growth are mirages. They are the precursors of longer-term economic woes that eventually force the creation of safety nets at a high real economic cost.

Rise in consumption that continuously outpaces domestic capacity to compete with cheap imports creates imbalances that initially cause trade deficits and later the closure of domestic industries, unemployment and social chaos.

Central bankers’ energies remain focused on containing economic volatility eroding in the process the importance of realizing the country’s potential. Correcting fundamental flaws that give rise to periodic market volatility vanishes from their priority list although fundamental flaws that cause the instability that central bankers spend their energies on correcting all the time, remain un-rectified.

The thinking that monetary policy should focus solely on managing the overall rate of inflation is seriously flawed. Central banks have to ensure long-term economic stability. By focusing merely on conventional inflation, central bankers take a limited view of their task. Central bankers fail because they begin to ignore the bigger canvas.

Central bankers shouldn’t be afraid of pricking a developing bubble. They shouldn’t wait for it to burst and then cut interest rates to mop the dirt from the economic canvas. Tightening monetary policy in an asset boom is like buying insurance against future risk of pervasive economic stress. There is no harm in sacrificing a bit of growth to forestall a sustained economic downturn in the future.

Admittedly, using the interest rate tool in isolation can impact the whole economy including sectors that are doing well. But can’t central bankers up the reserve requirements and impose selective credit controls? Or is it unfashionable in an era of ‘freeing’ the economies? Surely, we don’t need to see more bubbles being formed and burst to realize that most market players tend to be reckless.

Inflation of asset prices can be more dangerous than conventional inflation because a collapse in house or share prices can trigger a downturn that will take years to reverse. This highlights the fact that central bankers need to move quickly to contain unrealistic rises in asset prices. When price increases lose touch with reality (courtesy rapid growth in demand fuelled by borrowings at low interest rates) it is time to act.

Admittedly, central banks can’t be expected to target specific price levels but they can check unrealistic rises in prices using monetary policy alternatives, for a start, by pushing up interest rates above the current inflation level and follow it up with blunt warnings about further action to arrest asset price increases. More than once, prudent central banks used this combination successfully to scare the day lights out of the speculators.

Banking system plays a key role in achieving a fairer distribution of economic benefits. In the results periodically announced by banks, there are indications that this sector is consciously lagging behind in playing its distributive role. The scenario has eroded confidence in the financial system to a dangerous level. It is time for central banks to prove that they know the art of making difficult decisions tactfully – the demonstration of finesse.