The SBP and price stability | Political economics

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Pakistan headlines for high inflation. The Economist ranked the country the fourth most inflationary economy in the world out of 43 high inflation economies. Headline inflation reached 9.2% in October against 9% in September.

Worryingly, the country is expected to experience higher inflation throughout 2022. Higher and volatile inflation has economic and social implications. It erodes the purchasing power of the population. It does more for the poor who have lower incomes and spend almost half of that on food. In countries like Pakistan, where wage growth is low, high inflation can push many people below the poverty line.

Despite the fact that inflation in India stood at 4.3% in September, the highest offices of the Pakistani government continue to claim that it has done its best to control inflation; that the oil prices in the country are lower than in India, Bangladesh and even the United States.

These and similar statements point to the wrong approach and lack of commitment to controlling inflation. On the one hand, the common man feels humiliated and deceived; on the other, profit makers see it as a signal for further price increases. So expect higher prices in the coming months.

It is true that many factors, such as international commodity prices, are beyond government control and inflation is a global phenomenon, but Pakistan clearly has a much higher level of inflation. The prices of raw materials are increasing with each passing day. According to a press article, the government has decided not to publish a weekly inflation-sensitive price index. He has certain reasons.

Historically, price stability is an unfinished business in Pakistan. The State Bank of Pakistan (SBP) was meeting the evolving inflation targets set by the government. According to the SBP’s monetary policy framework, in order to maintain monetary stability, it is mandated to control “inflation close to the annual and medium-term objectives set by the government”. It turned out to be a daunting task. With such an approach, monetary policy achieves inflation targets but with eroded purchasing power.

The inflation targets stipulated by the government change frequently and erratically, often within wide margins, making it difficult to anchor inflation expectations. A study by the SBP shows that the inflation target rose to 12% in 2012 against 5% in 2004. Even if the SBP reached it at 100%, it will have eroded the purchasing power of the population.

It can be argued that monetary policy in Pakistan was not shaped in terms of price stability and the purchasing power of the population. The race to meet inflation targets has led to volatile and unpredictable movements in interest rates. Sudden changes in the direction of monetary policy, from tight monetary control to easy monetary control and vice versa, flooded the market with uncertainty. More importantly, the shaping of people’s expectations has been distorted. Higher average inflation levels have become the norm.

Without a doubt, the country’s monetary policy should ensure price stability. The SBP must do this. All excuses, whatever they are, must go. All the necessary arrangements must be made. The SBP, through its 2021 SBP law, is pushing for a number of fundamental structural changes.

The authorities must understand that the central bank, in particular monetary policy, has important distributive effects and cannot be undertaken independently of its socio-economic consequences..

The proposals include the establishment of an autonomous and independent central banking authority in the country while redefining the objectives of monetary policy. These changes will generate important consequences for social welfare, poverty and inequalities in the country in addition to effects on the macroeconomics.

The Sustainable Development Policy Institute’s (SDPI) ongoing work on the social footprint of monetary policy recommends a number of key actions and strategic directions to help the SBP stay in step with modern central bank practices. and move forward on the monetary policy social footprint agenda. .

Mainly, the SBP must guarantee price stability. Price stability is essential for social well-being, especially for low-income households. The inflation target should be set with an emphasis on the welfare of the public as a whole, instead of random inflation targets that stimulate growth. It must improve real wages in the short term and productivity growth in the medium and long term.

The SBP must adopt an inflation targeting regime in order to contain inflation at a given level, thus maintaining price stability and avoiding erosion of purchasing power. However, given Pakistan’s socioeconomic structure, low and volatile economic growth, a high degree of informality, high inequalities in income, consumption, wealth and employment, and the importance of fiscal policy, a Integrated inflation targeting regime (IIT) should be used instead. a standard inflation targeting (IT) model. Only an IIT meets the characteristics of developing countries.

Ensuring price stability will, however, require a clear definition of price stability. The SBP Amendment Act 2021 does not provide for this. In this regard, secondary legislation needs to be developed to identify what exactly price stability means. It should be a clear definition in black and white. More importantly, the level of inflation to target will be critical. 3 percent may be worth considering. The SBP can start by targeting inflation around 5% and move towards an average inflation target of 3% with deviations of -1 and +1.

This range can significantly reduce income and consumption inequalities imposed by higher inflation. At least the inequality will not worsen any further. This will help reduce poverty through the creation of more employment opportunities, increased income and purchasing power due to higher economic growth and lower inflation. It can also minimize the negative effects of monetary policy that result from a highly volatile policy rate. Why will a central bank raise the interest rate when prices are stable? A high inflation target, like 8% or 9%, can inflate inequality, even if it supports economic growth.

The arguments about inflation on the supply side must also go away once and for all. Targeting core inflation, which increases the command and control of the SBP, can help to a great extent. The SBP can target non-food, non-energy or average core inflation. This is necessary to eliminate the “inflation was on the supply side” mantra and improve the accountability mechanisms of the SBP. The secondary law should, however, make it clear which indicator of core inflation will be targeted.

Targets under each SBP goal should be directly quantifiable and written in black and white. Take, for example, the tertiary target of “Support[ing] The government’s economic policies to promote development and a more complete use of resources ”, as proposed in the SBP Amendment Act 2021. It is absolutely vague. It should be replaced by a clear goal, such as “maximum and sustainable employment”, as the Reserve Bank of New Zealand (RBNZ) has done.

This is important for at least three reasons. First, sustainable and maximum employment reduces income inequalities. Second, it may prompt the SBP to consider a combination of policies with favorable side effects. Third, it is directly quantifiable and therefore provides a more solid basis for accountability.

Once the inflation target, with well-defined specifications, agreed upon, a clear accountability system needs to be put in place. The SBP Amendment Act 2021 appears to be inconsistent in this regard. He asks for exemplary independence with almost no responsibility. The two cannot go hand in hand, for at least two reasons: first, monetary policy has serious implications for the daily life of the people, so it cannot be left unchecked; second, after granting its highly recommended independence, the SBP must adhere to its monetary policy and be held accountable if it does not. Secondary legislation should be introduced to put accountability mechanisms in black and white. These should answer the following questions: What will the accountability process be? Who will be held responsible for any deviation? What will be the acceptable explanations and penalties for unacceptable deviations?

The authorities need to understand that the central bank, especially monetary policy, has important distributive effects. It cannot be undertaken independently of its socio-economic consequences. To stay in tune with modern central bank practices and advancements on the monetary policy social footprint agenda, the SBP has a lot of work to do in the areas of communications, research and communication. decision making.


The writer is responsible for research in the Sustainable Development Policy

Institute and runs its Policy Solutions Lab. He tweets @sajidaminjaved

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