THIS is with reference to the article ‘Our monetary policy goals’ (Jan 29) by a former deputy governor of the State Bank of Pakistan (SBP) about the recent legislation related to the SBP. The writer supports the clause of the recent legislation which prohibits the government from borrowing directly from the central bank as, in his view, direct borrowing from the central bank leads to inflation.

While this is true that uncontrolled currency printing leads to hyperinflation, it is also true that monetary expansion in a calculated way has been the most popular tool of central banks around the globe to deal with financial crises. For instance, all advanced economies relied on central bank borrowings to deal with the crisis created by the Covid pandemic.

The money supply in the United Kingdom increased by 21 per cent in 2020, and it went up by a further 8pc in 2021. This increase was meant to meet the Covid-related expenditure. Because of these expenditures, the debt-to-GDP ratio in the UK jumped from 82.6pc to 95pc during 2020.

Despite this huge borrowing, quite surprisingly, the inflation in the UK over the same period was less than the preceding year. This means that there exist certain conditions under which the borrowing from the central bank does not lead to inflation. Such borrowings provided hundreds of billions of pounds to the UK government without any physical resource and inflation.

Suppose the entire inflation in the UK today can be attributed to the monetary expansion of 2020, even then the data states that 21pc expansion in money supply led to an increase of only 6pc in the price level. This means there is a free lunch of 15pc without any inflationary cost.

Why not get the advantage of this when the country is passing through the toughest crisis of history?

In 2018, the direct lending of the SBP to the government was more than Rs5 trillion and if the assumption of inflationary central bank borrowing was valid, the inflation at that time should have been higher. But the ground reality is exactly opposite, which indicates failure of the assumption that central bank borrowing is always inflationary.

Similarly, the writer assumes that making price stability a primary objective of central banking would ensure sustained growth. In fact, it is not a big deal to make price stability a primary objective of the central bank, but the problem is with the tool used to achieve price stability. In a typical inflation-targeting framework, interest rate is used as the tool to achieve price stability, and Pakistan is also following the same framework.

If one looks at the SBP monetary policy statements for the last few years, one will find that it has already been using policy rate in an attempt to control inflation, but history shows that the SBP has never been successful in achieving this objective.

In 2018, the interest rate was 5.75pc and inflation was about 4pc. Fearing a spike in inflation, the SBP increased the policy rate to 13.25pc and the inflation also went up, reaching double digits. In 2020, due to Covid, the SBP had to bring down the policy rate and, subsequently, inflation also decreased. Likewise, today when there is an upward trend in terms of policy rate, inflation is also on an upward trajectory.

The cost of public debt in Pakistan today is 39 multiples of the cost in the United States. With so much cost, the SBP should have a comprehensive analysis of the costs and benefits of the interest rate policy, but it does not have any. In a seminar in April 2021, I was part of a panel alongside the writer and the head of SBP’s Monetary Policy Department. I asked the two panellists to show any single evaluation report of the high interest rate policy, and they could present nothing.

Now, through this legislation, the SBP has got a chance to avoid accountability to any of the lawmaking or law-enforcement institutions. Instead of granting the SBP further autonomy, what is needed is to ask the central bank to present a technical audit of the mark-up payment in the past and a report on their usefulness. Otherwise, the SBP must be held accountable.

Dr Atiq ur Rehman
Director, Kashmir Institute of Economics,
University of Azad Jammu and Kashmir AJK

Published in Dawn, February 15th, 2022