AS Pakistan deals with its inflationary crisis, it is crucial to explore the nature of the crisis so that radical policies may be planned to address it. Looking back to the insights of the 18th-century economist Richard Cantillon, whose ideas inspired luminaries like Adam Smith and David Ricardo, we are facing what is known as the Cantillon effect, which describes uneven changes in relative prices that result from alterations in money supply.

The Cantillon effect posits that the effects of an increase in the money supply depend on who initially receives this new money. In essence, this monetary expansion shifts income distribution in favour of the early recipients of the newly created money. Subsequently, the preferences of these initial beneficiaries dictate which goods experience increased demand, while others see a relative decrease. This, in turn, affects the production levels of various goods, and ultimately influences investments.

Economists having various orientations have offered persuasive arguments regarding the Cantillon effect, but there seems to be a consensus that the massive money creation by global central banks in response to the Covid pandemic is now having worldwide repercussions, particularly in terms of inflation.

The repercussions of this new wealth generation has created both winners and losers. Typically, monetary expansions orchestrated by central banks tend to benefit the wealthy and large corporations, especially the financial industry. Conversely, as prices rise due to inflation, wage earners and small to medium businesses are often the most adversely affected since they receive this new money at its tail end.

Consider the Temporary Economic Refinance Facility (TERF) as an example, where an amount of Rs425 billion was injected into the economy, enabling selective 628 large business-owners to access new credit at fixed low interest. While the initial intent was to kickstart the economy post-pandemic and to stimulate job growth, it remains challenging for central authorities to determine precisely where this money was spent.

If it was used by the bourgeois class to purchase, say, luxury cars, then the TERF’s intended purpose was not fully realised. This raises the question of how monetary authorities can monitor and measure the success or failure of TERF. Did it trigger the Cantillon effect, or did it genuinely benefited industry in terms of job creation and economic growth?

This is where the element of Central Bank Digital Currencies (CBDCs) could offer significant advantages. The introduction of CBDCs in the event of a major economic contraction would have meant that the funds remained in digital wallets at the central bank, and the authorities could closely track their utilisation. In fact, a programmable CBDC could have allowed the State Bank of Pakistan (SBP) to set coded rules, ensuring that the funds were directed towards productive investments, like machinery, rather than frivolous expenses, like, say, cars.

The work done on CBDCs by the Innovation Hub of the Bank for International Settlements (BIS) presents a compelling opportunity for Pakistan. While the Chinese CBDC, the ‘digital yuan’, offers valuable insights into implementation, it is crucial that we use such technology responsibly, avoiding any undue control or political interference.

Adil Hanif
London, UK

Published in Dawn, September 20th, 2023