After the coronavirus struck, central banks took the wheel and provided economic policy responses to the pandemic. Expansionary monetary policies, especially during lockdowns, have become the “only game in town”. The key rates were immediately lowered. Quantitative Easing has been practiced as if there is no tomorrow.
The State Bank of Pakistan (SBP) has also followed suit. Loans have been scaled down; the key rate was cut by 625 basis points to 7% from 13.25% in less than three months. Concessional financing of Rs 435.7 has been approved for businesses under the Temporary Economic Assistance Facility (TERF). The debts have been rescheduled.
While these and similar programs have been crucial in stabilizing economies and financial markets during the lockdown, in order to control the spread of Covid-19, the central bank and monetary policy in a changing world now requires rethinking. at a more fundamental level.
The social footprint of central bank policies, in particular that of monetary policy, is receiving serious attention. Central banks, moving beyond the formal mandate of price stability, are paying increasing attention to poverty, inequality, climate change and other issues.
The debate, however, remains largely absent in Pakistan. It is time for the SBP to consider that its decisions and actions affect poverty, inequality and other social outcomes. Other types of monetary policy interventions that have the same aggregate effect – for example, rising inflation – have a different impact on different population groups.
Take, for example, reducing the interest rate or increasing the money supply. Both lead to higher inflation. The latter, however, will affect the poor relatively more. As the poor usually hold their money in the form of cash, an increase in the supply of foreign exchange in countries like Pakistan will generate an oversupply of cash mainly among them. This will lead to a relatively higher level of inflation in the prices of basic commodities consumed by the poor, which mainly include food, resulting in food inflation.
This, in turn, can disrupt household spending patterns, as low-income households spend a significant portion of their income on food. A recent study showed that due to a spike in food inflation, low-income households spent 46% of their income on food in April 2021, up from 30% in March 2020.
As a result, households may have to borrow to meet other needs, such as health expenses and children’s education. A recent SDPI study suggests that half of poor households in Pakistan are in debt. More importantly, about 80 percent of these households have defaulted on their loans.
Higher food inflation can increase borrowing on the one hand, while further weakening debt repayment capacity on the other. Likewise, monetary policy decisions affect inequalities in income, wealth and consumption through several channels; difference in sources of income, composition of portfolio, sector and occupation of work, and role of the credit market, such as savers and borrowers.
The World Economic Forum’s Global Future Council on the New Agenda for Fiscal and Monetary Policy has identified three ways to advance the social agenda in macroeconomic policies. It is above all a question of “filling in the inequalities”.
The council concluded that “while the current monetary policy tools might be effective in maintaining liquidity, they might not encourage structural transformation towards fairer, more equitable and more sustainable economies.” IMF research concludes that inequalities should be factored into central bank decisions. An IMF working paper, published in September 2020, recommends that the fight against inequality be an explicit objective of monetary policy.
Researchers and policymakers are finding more and more evidence that monetary policy actions affect socio-economic indicators such as poverty, inequality, unemployment.
Distributive impacts, which are perceived to be short-term in nature for developed countries, can create long-term structural inequalities in access to education, health and skills development in developing countries. In particular, they can have long-term effects in countries like Pakistan, which have lower financial inclusion, poor social spending, and a predominantly informal economy. Together, these characteristics can convert a short-run distributional impact into long-run structural inequalities.
With few exceptions, much of the existing research in Pakistan has largely ignored the possible social implications of monetary policy interventions. To some extent, the available literature explores the overall impact of inflation on wages and employment. But issues such as how day-to-day monetary policy actions affect the poor, poverty and inequality, remain largely overlooked.
It worked to decouple monetary policy from the ordinary man. In fact, the research guiding post-Covid monetary policy is particularly lacking in this regard. Interestingly, the terms “inequality” and “poverty” do not appear in the title of any of the 107 SBP working papers published over the past 20 years.
The formulation of a well-being short-term monetary policy must be informed by its social effects. Contrary to the common belief that monetary variables such as money supply and interest rates have no real influence on the economy, researchers and policymakers are finding increasing evidence that the actions of monetary policy affect socio-economic indicators such as poverty, inequality, unemployment.
Opponents of this idea generally argue that tackling inequality and reducing poverty is not the goal of monetary policy. Any proposal to reconsider the monetary policy agenda is therefore unjustified. It is important to note here that the new agenda in no way calls for replacing price stability with the reduction of poverty and inequalities. It simply suggests that monetary policy, like any other policy, must take into account the socio-economic impacts of its actions. In addition, recent IMF research suggests that inequalities distort the transmission of monetary policy and undermine its effectiveness. It must therefore be taken into account in monetary policy decisions.
The unequal footprint of monetary policy is particularly relevant for the SBP now, as it aims to ensure greater autonomy. A World Bank working paper, released in January 2021, identified three channels through which central bank (CBI) independence, if left unchecked, can lead to increased inequality. First, central bank independence indirectly restricts fiscal policy and weakens a government’s ability to engage in redistribution. Second, the independence of the central bank prompts governments to deregulate financial markets, which generates a boom in asset values. These assets are mainly in the hands of the wealthier segments of the population. Third, to contain inflationary pressures, governments actively promote policies that weaken the bargaining power of workers.
These channels of increasing inequality of the CBI are likely to be stronger during the initial phase of independence – as in the case of the SBP, as the institutional capacity, the monetary policy framework and the monetary instruments do not. not match the newly adopted inflation targeting regime. However, this proposition does not in any way mean that CBI is bad. In fact, he actually advises that a more independent central bank has a greater role to play in tackling inequality, and that the existing framework, monetary policy actions and instruments must take into account their social implications.
It is therefore high time to focus on social outcomes at the very beginning of the transition to a more independent SAP adopting inflation targeting. The SBP should broaden its research agenda to explore how its decisions and actions can affect social outcomes such as poverty and inequality. It must then work to minimize these negative impacts. At a later stage, the SBP should endeavor to calibrate decision-making processes in order to fine-tune monetary policy actions and instruments accordingly.
Central bank and monetary policy, which takes into account social implications, can improve Pakistan’s progress towards social and economic development. At the same time, it can help SBP communicate the importance of SBP and monetary policy to the general public. This can help broaden and deepen the scope of the SBP, which improves the effectiveness of its monetary and other policies.
The author is a researcher and directs the Policy Solutions Lab at the Sustainable Development Policy Institute (SDPI), Islamabad. He tweets @sajidaminjaved