The monetary policy affects the day-to-day life of common man, and impacts poverty, inequality and other social outcomes. The State Bank of Pakistan (SCP), therefore, needs to assess, consider and communicate the side effects of the monetary policy to public for greater transparency, and the government to align the fiscal and regulatory policies to counter unintended consequences.
The monetary policy decisions and instruments can affect poor and rich differently. It should thus be designed with improved welfare considerations. Take the example of raising interest rate. A slowdown in economy resulting from higher interest rate affects those contributing to the labour market more than those in the capital market.
It is important to note that incorporating social consideration into the SBP’s policies, particularly the monetary policy, is not an end goal for Pakistan. It is rather a tool to improve peoples’ welfare. The integration of monetary policy into developmental policy is a crucial step towards greater community engagement in monetary policy and enhancing the SBP’s understanding of how policy decisions impact the daily lives and livelihoods of all citizens.
It is imperative that the SBP expands its research agenda to explore how its decisions and actions can affect social outcomes, such as poverty and inequality. It can then, work towards minimizing these adverse impacts. The bank should convey the impact of its actions to public in a non-technical manner for their better understanding of the issues. At a later stage, the SBP should work towards calibrating decision-making processes and refining monetary policy actions and instruments accordingly.
The SBP may consider in 5 percent inflation target in medium term for Pakistan. A higher inflation target, such as 7 percent, 8 percent or 9 percent, as many of the estimates suggest, does not commensurate with the welfare aspect.
There is a lot of talk among the policy circles these days that the growth rate will be compromised if the SBP focuses on solely on inflation. The SBP’s priority should be to control and keep inflation stable, and the growth rate will show positive outcomes.
The SBP Amendment Act 2021 explicitly mandates the bank to focus on domestic price stability, and deliver a “low and stable inflation”. Prior to it, the SBP was mandated to control “inflation close to its annual and medium-term targets set by the government” – which has proven a daunting task.
The SBP has over the years compromised on price stability, distorting the conduct of monetary policy and generating serious consequences for economic activity in the country. By moving towards the monetary policy framework of targeting inflation, as proposed in the SBP Amendment Act 2021, the bank may help overcome the problem. The SBP needs to now deliver on price stability to prevent peoples’ purchasing power from eroding.
However, given the socio-economic structure of Pakistan — lower and volatile economic growth, high degree of informality, higher inequalities of income, consumption, wealth and employment, and fiscal policy importance — an Integrated Inflation targeting (IIT) regime should be employed, rather than a standard model of Inflation Targeting (IT).
In this regard, the SBP may consider 5 percent inflation target for Pakistan. A higher inflation target, such as 7 percent, 8 percent or 9 percent, as many of the estimates suggest, does not commensurate with the welfare aspect. It will be meaningless to target such a higher level of inflation in the new regime.
The SBP, therefore, should target a welfare enhancing inflation level. While it may start with targeting 5 percent inflation in the first three to five years, it should move towards targeting average inflation of 3 percent with deviations of -1 and +1.
The level of inflation should:
- Improve purchasing power of the people, particularly of the poor working in elementary sector, which have a lower nominal wage growth.
- Substantially reduce the income and consumption inequality imposed by higher inflation. At least, it will not deteriorate inequality.
- Help reduce poverty through greater job opportunities, increased income and purchasing power on account of higher economic growth and lower inflation.
- Minimize adverse effects of monetary policy that arise from a very volatile change in policy rate. Why would a central bank raise the interest rate when prices are stable?
- Improve real wage growth through lower inflation in the short run, and productivity growth in the medium to long run.
Lower and stable inflation clears the uncertainty present in the market. It helps facilitate investment decisions which lead to enhanced economic activity and productivity growth.
A more independent central bank has a larger role to play in fighting inequality and other social outcomes. It’s monetary framework, policy actions, and instruments should consider the social implications as well. In fact, a more independent and accountable SBP will ensure price stability.
The autonomy of State Bank of Pakistan is critical to price stability. The central bank through an independent policy may be in a better position to consider the side effects of its policies and actions. It may also be able to update its policy tool kit, particularly the monetary policy framework.
A more independent central bank has a larger role to play in fighting inequality and other social outcomes. It’s monetary framework, policy actions, and instruments should consider the social implications as well. In fact, a more independent and accountable SBP will ensure price stability. Therefore, the bank’s autonomy must be balanced with greater accountability, transparency and oversight. In a democratic country, every institution must be accountable, transparent and credible.
The SBP’s accountability can be ensured by setting clear inflation targets and financial stability targets. The parliament must mediate by introducing legislation to separate and define the regulatory powers of the SBP and government, without any external influence.
The article is based on the study conducted by the author on the Social Footprint of Monetary Policy.
The author is Deputy Executive Director, SDPI.