Plz comment: The new monetary policy

[shtanzeel]

Dear all,

What are your comments about the recent monetary policy?

SBP has decieded to keep the discount rate at 14%, do you think its a step in right direction? please give a few arguments with your answer to make the discussion more informative

[evez]

State Bank of Pakistan has kept the policy (discount) rate unchanged at 14 percent.According to Governor SBP, this is necessary to control stubborn inflation.

This nostrum might be acceptable if there was any evidence that the present strict monetary policy, of which the policy rate is the key, was succeeding in its avowed aim of curbing inflation.Recession-hit economies everywhere in the world, particularly the developed world, while monitoring inflation carefully, are cutting interest rates to encourage investment and economic recovery. For Pakistan, with the dubious distinction of being one of the last destinations of choice for investment, given our terrorism and law and order crises, should take a leaf out of their book and, in recognition of the fact that high interest rates are discouraging investment while failing to curb ‘stubborn’ inflation, revisit the current monetary policy. The need of hour is decisions and policies that not only boost investment but also attract foreign investors.

[shtanzeel]

sir, do you advocate, a reduction in policy rate?

12.9 is inflation in february 2011, on YoY basis. Market rate of interest with 14 % DR, means KIBOR 14.5-15% and market interest rate at 17-18%. So this is no doubt hampering growth.

Secondly, the inflation nature is cost push, so it cannot be controlled by reducing Investment. Economy is already on positive track once again, especially LSM also experiencing a good growth.

But,sir, if we try to boast growth by reducing policy rate, what will happen to inflation? we did in 2000 era, but the result was 25.3% CPI inflation YoY basis April, 2008. So the real rate of interest was negative in the economy.

So if we try to achieve growth it will cost us price stability. So don't you think SBP has done right to be cautious by not altering Interest rate?

I think they have right justification.
They can reduce policy rate, provided fiscal policy moves in same direction. But if fiscal policy is expansionary in nature, the monetary policy will fail to control inflation. So the need is for government to control its deficit, to control inflation. Once inflation in under control, you can lower policy rate and give a kick off to your growth process.

So i guess that its right to not alter the policy rate.

[evez]

well im in favor of reduction in interest rate


Interest rates control the flow of money in the economy. High interest rates curb inflation, but also slow down the economy. Low interest rates stimulate the economy, but could lead to inflation. Therefore, you need to know not only whether rates are increasing or decreasing, but what other economic indicators are saying.

* If interest rates are increasing and the Consumer Price Index (CPI) is decreasing, this means the economy is not overheating, which is good.

* But, if rates are increasing and GDP is decreasing, the economy is slowing too much, which could lead to recession.

* If rates are decreasing and GDP is increasing, the economy is speeding up, and that is good.

* But, if rates are decreasing and the CPI is increasing, the economy is headed towards inflation.

now here is the data

Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2011 14.19 12.91
2010 13.68 13.04 12.91 13.26 13.07 12.69 12.34 12.79 13.77 14.17 15.48 15.46
2009 20.52 21.07 19.07 17.19 14.39 13.14 11.17 10.69 10.12 8.87 10.51 10.52
2008 11.86 11.25 14.12 17.21 19.27 21.53 24.33 25.33 23.91 25.00 24.68 23.34

Although inflation rate was recorded low in feb,2011 but we cant predict the same behavior in future, At the same time we need to consider other indicators i.e slow growth rate ( 2.0 %), unemployment 5.50 % etc...

Interest rates affect the economy slowly. If we try to control inflation by interest rates, the result will consume enough time to sweep out all investors and will change investment behavior of people.

As u said "Secondly, the inflation nature is cost push, so it cannot be controlled by reducing Investment"
so if this policy is not going to control inflation, why we are reducing investment?


regards,
Eve's Daughter

[shtanzeel]

so you are not in favor of fine tuning the economy at the right time. You want that growth be stiumulated, at the cost of inflation. Only growth rate positivity is to be seen? then sir, when inflation will be above 20%, then your real rate of interest will be negative? dont you think it will discourage savings?

Secondly, although cost push inflation cannot be controlled by reducing AD. But by reducing i, thus KIBOR, and market i, we will accelerate inflation. so as it in the past accelerated above 20% and the yearly average was 20.8 in last one two years, and then we had to resort to increasing policy rate to 15%; this sir resulted that LSM got -8.3% growth and Manufacturing too got negative growth. it was major crops which made the growth rate +ive that year,
Unemployment rate below 6% is even allowed by US economists for US economy even. So its not a concern.

Its wise therefore, if cost push element is vital in producing inflation, we should not feul the fire by adding demand element in it.
Slowing the growth is better option, a stitch in time, rather than doing it after a year or so, when we have to make 9 stitches.
i at the same time am not saying that i be increased, as it can discourage investment.
so my considered opinion is, that we need not to hurry up to get growth. what i think we need is:
1. Keep i rate constant,
2. the government control its expenditure and stops borrowing.
3. as inflation wents single digit, we can lower i gradually so as to ensure that the resultant growth is sustained.
We should not repeat mistakes done in 2000-2008.

You are right that we need to boast growth, but for this we should not do haste.

[evez]

no...I am in favor of fine tuning the economy at the right time.i dun want growth be stiumulated, at the cost of inflation.

"higher interest rates tend to lead to lower inflation; and lower interest rates tend to lead to higher inflation".This is the standard explanation given out by economists. However, if you have not been taught this and you looked at it rationally then, surely, higher interest rates charged by the banks actually leads to higher prices. Why? Because the producers of the goods and services, who borrow the money from the banks, have higher costs associated with servicing those loans used in producing the goods and services. And because the producers are in the business of making profit then they have to pass on to the consumer the additional higher costs in the prices charged for the goods and services. So higher interest rates must lead to higher prices.

a change in the official Bank Rate takes around two years to have its full impact on inflation

lets check this decision..lets check its debit and credit side

debit side: unemployment (leading to brain drain nd increase in crimes), slow growth of economy, low gdp , internal and external debt ,low investment, low production, low production will automatically lead to demand pull inflation

credit side: low inflation rate ( depending on other factors remains favorable)

what i think we need is:

1. interest rate should be favorable enough to encourage investment
2. the government control its expenditure and stops borrowing.
3. good fiscal measures to control inflation and increase government revenue

[shtanzeel]

@ above, first of all give reference of this statement of your that time lag in pakistan is two years? any empirical time series study using appropriate technique and published in some good impact factor journal showing for pakistan economy 2 year time lag. Because if time lag involved is two year inpakistan strict monetary stance would have failed to control inflation in 2009. from over 20% to single digit. (lets make the high base effect argument constant for a while in the computation). so kindly qoute 2,3 studies in some recognized journals to prove that it takes 2 years for DR to impact inflation.

Too high interest rate no doubt increases cost of business, let me further add, it causes NPL, but does it means, that; we should lower it to such an extent that their is excessive lending?. If there is excessive growth of money supply, how is it possible that inflation doesn't emerge. Too high interest rate no doubt makes cost of bussines high and it reduces growth of manufacturing no doubt in it. but we cannot make it that much low, that real rate of interest becomes negative in future.

You further overlooked what about having Negative rate of interest? if inflation is 20% and i=10 then real rate of interest is negative as it was in 2008-09.then what?


I agree to your steps no 2 , 3.

Secondly, how will you reduce unemployment in pakistan by growth. Take last ten year data of growth and unemployment and you will find "job less" growth.

Lastly, sir, all your arguments come to failure at one possibility. What about pessimissm or optimism inthe economy?if there is pessimissm in economy, any attempt to augment i, will fail to increase investment.

counter argument, if you say our situation is optimistic, then if i is such high then why not people from all over world come to pakistan and earn profits by lending at v high i in pakistan?

------------------------

"any attempt to augment i, will fail to increase investment" is typing error. any effort to augment growth by reducing interest, will fail to increase investment.

[evez]

"a change in the official Bank Rate takes around two years to have its full impact on inflation" is the analysis of BANK OF ENGLAND in their publication. Now you can better judge if a developed country needs 2 years.....what would be the time lag for a developing country where recognition lag, policy making lag and implementation lag are common.

They further explain this phenomenon as "A change in the official Bank Rate may have some instant effects - for example on consumers' confidence - which may influence spending straight away. But, more generally, a change in the official Bank Rate will take time to influence consumers' and firms' behavior and decisions. Overall, a change in interest rates today will tend to have its full effect on output over a period of about one year, and on inflation over a period of about two years. This is, of course, a very approximate guide."

In this sense, monetary policy has to look ahead. Interest rates have to be set based on what inflation might be over the coming two years, not what it is today - though that is a relevant consideration. Policy-makers have to judge what the likely economic developments will be over that period, in particular what the rate of growth in demand will be relative to the growth in supply (output). This is why the Monetary Policy Committee uses forecasts of growth and inflation to help it decide on the right level for interest rates.

Your points are although very valid but at the same time we should see the other side. you are an economist and of course analyze in a more deeper and better way. This is all how i analyze the current scenario.

[shtanzeel]

Honorabl evez, please see that many of the theories of west have proved inapplicable in pakistan. however i appreciate your issue raised of time lag is a perfect topic for a research paper, by analysng impact of DR on inflation in pakistan and the time lag factor involved in it.

Till we have empirical support by time series analysis for pakistan, i am unable to support the argument that it will take 2 years as the time lag.
however, if it is proved by research being a student of economics till last breath, i will be willing to make corrections in my point of view.