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Updated 04 May, 2020 08:42am

Polemics of discount rate adjustment

THERE has been acerbic debate during the past few weeks on the discount rate adjustment to zero or a near-zero level in Pakistan to stimulate the sagging economy following coronavirus that has engulfed the whole globe.

The initial response of governments and central banks to Covid-19 was framed on the understanding that the virus was geographically limited to China. Therefore, the application of the classical model of Milton Friedman’s theory of “helicopter money” was thought to be adequate to offset adverse effects on their economies by resorting to monetary expansion to make payments directly to individuals and business houses.

This was considered enough to provide an impetus to the economy by stimulating aggregate demand as this was the recipe that successfully tried to counter the global financial crisis of 2008-09. However, when Covid-19 was declared a pandemic, the monetary model, as adopted initially, could no longer deliver.

The underlying reason is that it is predominantly a supply-side phenomenon. This is best described in an article titled “Implications of coronavirus” dated March 18, 2020, in The Financial Times Adviser by David Thorpe: “while the coronavirus pandemic is a problem on a different scale to the European debt crisis (2011), what both events have in common is that they are both supply-side shocks to the economy and demand-side shocks occurring at the same time; something which rarely happens in economics.”

This point was more emphatically made by the Chief Economist of the Bank of England Jeremy Thomas Cook following the reduction of the discount rate to 0.1 per cent on March 19. He said the fresh rate cut takes interest rates to the lowest they can feasibly go and went on to argue that monetary policy has nothing to do with supply-side shocks. It signalled direct intervention by the government through the offer of large chunks of fiscal packages that aimed at fighting the virus and catering to the basic needs of people.

The existing policy framework has become irrelevant to govern an economy the size of Pakistan with its limited structural base

Apart from several packages of support by Dubai and Abu Dhabi governments that aimed at reducing the burden on consumers, the United Arab Emirates government launched a new set of initiatives under “Ghadan 21” on March 16, which included water and electricity subsidies to citizens, a generous package for small and medium enterprises comprising subsidies on inputs including interest on loans, waiver of fees and duties to reduce the cost of living, etc.

Similar fiscal packages were put into effect by Qatar, Kuwait, Bahrain and Saudi Arabia. The most recent example is that of the United States of America which commissioned a huge relief package of $2 trillion on March 27 that focused on fighting Covid-19, providing relief to jobless, laid-off workers and stimulating small businesses as well as big companies under distress.

It is noteworthy that an entirely new model has evolved during the past few weeks that emphasises all-out fiscal support to economies from their domestic structural base following a collapse of the global economic order, characterised by the following features:

1) The pre-corona economic order stands paralysed with a complete suspension of transport that includes shipping, airlines, railways and trucks. This has brought international trade to a standstill. Agriculture and industries dependent on raw materials, machinery and spare parts are clogged. These developments have a marginalised impact on the flow of capital in the balance of payments account. In fact, the developing and emerging economies have witnessed capital outflows exceeding inflows.

2) Each country – super powers or the rest – is engaged in its own war against the virus. The inwardness has peaked to such a level that the governor of New York complained in his briefing on March 30 of the lack of coordination among 50 states and the federal government so much so that each is competing with the other for placing orders to China for medical equipment and thus throwing up prices by many times.

3) International institutions like the United Nations, International Monetary Fund, World Bank and World Trade Organisation, which support and regulate the system of international governance, have lost their significance under the pressure on countries for protecting the lives of people and providing them succour.

4) Each country disconnected with the globe is compelled to depend on its resources to fight the virus and ensure uninterrupted supplies of basic needs from its own structural base of the economy.

In the present international scenario, Pakistan has to formulate a strategy to fight Covid-19 and keep the supply chain of essential goods flowing to its people from its domestic base. This requires an adjustment of its economy to post-Covid-19 realities.

It means that all existing policies regarding agriculture, industry, trade, foreign exchange and interest rate have to be fixated into a new framework that can help meet the twin goals. It seems strange that a pre-Covid-19 instrument of a discount rate cut to zero or near zero is still insisted to stimulate the economy.

The bottom line is that the post-corona scenario is a different world where systems such as total reliance on discount rate adjustment have become ineffective. Furthermore, the existing policy framework has become irrelevant to govern an economy the size of Pakistan with its limited structural base. The government should not succumb to the pressure of rich groups who stand outside the ambit of the framework and are clamouring for a bail-out package to protect their wealth.

The writer is a retired joint chief economist of the Planning Commission

Published in Dawn, The Business and Finance Weekly, May 4th , 2020

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