Looking after poor and low income groups
By Aftab Ahmad
Inflation targeting is defined as a government policy to fix a target for the inflation rate for the coming year. After the announcement of the inflation target, the Central Bank of the country makes an effort to achieve inflation targets through the use of its monetary policy. If the inflation threatens to exceed the target, the Central Bank would ordinarily raise the federal rate or the bank rate to decelerate the pace of economic activities, so as to bring down the inflation rate. On the contrary, if the inflation rate is too low, the central bank may consider lowering the bank rate or the federal rate to accelerate the pace of economic activities and promote economic growth.
In 1980-81, for example, the US broad inflation rate exceeded 10 per cent. Paul A. Volker who was the Chairman of the US Federal Reserves at that time, raised the federal rate to as much as 19 per cent, with the full backing of the then President Reagan. The policy proved successful and inflation came down to 3 per cent by 1983. Later, in the same way, Alan Greenspan - the present Chairman of the US Federal Reserve - raised the fed rate to 9.75 per cent in February 1989 to bring down the inflation rate from its higher level. As a result, the US economy slipped into a mild recession in July 1990 that lasted until March 1991. The US, however, does not have formal inflation targets, at present.
The policy of inflation targeting is presently followed in many countries of the world including Britain, Canada, Australia, New Zealand, Brazil and South Korea etc. All those countries, which follow the aforesaid policy, endeavour to keep their economic growth moving while having a check on the rate of inflation. According to a recent study by Goldman Sachs and Co, the United States and Japan (which do not have formal inflation targets) have more volatile bond and stock markets, compared to those countries, which follow the policy of inflation targeting.
The present Chairman, Alan Greenspan (due to retire on January 31, 2006) is reported to be of the view that the Fed can control inflation without announcing a target rate. He thinks that an announced target would make it difficult for the US Federal Reserve to act in a flexible manner in a crisis. However, his nominated successor Ben S. Bernanke (who is a supporter of inflation targeting) had expressed the view that a transparent Federal Reserve policy (indicating the inflation target rate) could be more helpful in promoting non-inflationary economic growth. This, he believed, would give the business community and consumers certain knowledge about the future course of interest rates and inflation. Bernanke argues that in the event of a crisis, the Fed would do whatever it requires to stabilise the economy and no one would blame them for doing so.
So far as Pakistan is concerned, we have been fixing inflation targets for forthcoming years since long, at the time of the announcement of our federal budgets. All possible efforts are then made by the government to see that inflation does not exceed the target fixed for it. Monetary and fiscal policies are used and all other necessary measures are taken to achieve the aforesaid objective.
In Pakistan, double-digit inflation rates have always been viewed with concern. Considering that nearly one-third of the country’s population lives below the poverty line, independent economists have been of the view that inflation rates should be at the lowest possible level. In the US, 1 to 2 per cent inflation is considered reasonable. Since a much higher GDP growth is needed to deal with the problems of unemployment and poverty facing the country, the inflation rate may have to be a little higher - say up to 5 per cent. However, inflation rates higher than that would surely hit the poor and the people belonging to fixed income categories. Besides, higher inflation would, also, jeopardise our exchange rate stability and exports, which are crucial for a rapid and sustained economic growth.
The policy of inflation targeting has, at times, been criticised by economic analysts on the grounds that inflation is not always the result of an increase in the volume of money and credit. Due to the aforesaid reason, raising the interest rate cannot always control inflation. If inflation is the result of other factors such as increase in the international oil prices or less production of wheat or sugar in the country, raising the interest rate could do more harm than good to the economy.
The experience of Pakistan shows that inflation in this country has often been the result of factors other than an increase in money supply. For example, prices of certain commodities go up before the announcement of the federal budget, due to pre-budget speculations. In July/August, prices often come under pressure due to interruptions in supply resulting from monsoon rains and floods. Prices of certain commodities register increase on the eve of the holy month of Ramadan, because of a rise in consumer-demand for these items on the aforesaid occasions. In addition, inflation in Pakistan is often the result of hoarding, profiteering, smuggling and monopolistic tendencies. In all such cases, there is little that the State Bank can do to bring down the prices. The correct course for the government in all such cases would be to study a particular situation, identify the cause/causes of the price increase and then take necessary measures to remove the causes.
However, sometimes we come across a situation which is of a mixed nature and where increase in the volume of money and credit is, also, partly responsible for the inflationary pressure. An instance is the inflationary situation witnessed in the country during the last one to two years. The increase in prices, in this case, was attributable to a multitude of factors such as liberal credit facilities, more disposable income from remittances, speculative hoarding and profiteering, smuggling of wheat across the borders, effect of cost-push inflation, lack of government control on monopolies and cartels, corruption and so on. Since increase in the volume of money and credit was thought to be behind the hoarding of wheat and speculative investment in stocks and real estates, the State Bank of Pakistan (SBP) had raised the bank rate and resorted to open market operations to mop up excess liquidity.
In the same way, to deal with real and artificial shortages of items of daily use, the government had allowed duty-free imports of essential commodities. This helped in bringing down inflation from over 9 per cent last year to 8 per cent during the current year.
However, unless the government takes determined action to deal with hoarding, profiteering, smuggling, speculation, corruption, power enjoyed by the monopolies and cartels in the country and the problem of poor governance, inflation can not be fully brought under control.
Even if the government takes action on all the above-mentioned fronts, inflation rates are likely to remain a little bit higher, due to higher international crude oil prices. However, the level of inflation in Pakistan would then be comparable with the level of inflation in other countries of the region such as China and India.
It may be concluded that the concept of inflation targeting may be relevant in the context of Pakistan only in so far as an inflation rate (preferably below 5 per cent) may be fixed on an annual basis and, thereafter, all possible efforts are made to keep it within target. This is necessary because the current rate of inflation at 8 to 9 per cent, if not controlled, may jeopardise the macro-economic stability achieved by the country in recent years.
Inflation targeting is defined as a government policy to fix a target for the inflation rate for the coming year. After the announcement of the inflation target, the Central Bank of the country makes an effort to achieve inflation targets through the use of its monetary policy. If the inflation threatens to exceed the target, the Central Bank would ordinarily raise the federal rate or the bank rate to decelerate the pace of economic activities, so as to bring down the inflation rate. On the contrary, if the inflation rate is too low, the central bank may consider lowering the bank rate or the federal rate to accelerate the pace of economic activities and promote economic growth.
In 1980-81, for example, the US broad inflation rate exceeded 10 per cent. Paul A. Volker who was the Chairman of the US Federal Reserves at that time, raised the federal rate to as much as 19 per cent, with the full backing of the then President Reagan. The policy proved successful and inflation came down to 3 per cent by 1983. Later, in the same way, Alan Greenspan - the present Chairman of the US Federal Reserve - raised the fed rate to 9.75 per cent in February 1989 to bring down the inflation rate from its higher level. As a result, the US economy slipped into a mild recession in July 1990 that lasted until March 1991. The US, however, does not have formal inflation targets, at present.
The policy of inflation targeting is presently followed in many countries of the world including Britain, Canada, Australia, New Zealand, Brazil and South Korea etc. All those countries, which follow the aforesaid policy, endeavour to keep their economic growth moving while having a check on the rate of inflation. According to a recent study by Goldman Sachs and Co, the United States and Japan (which do not have formal inflation targets) have more volatile bond and stock markets, compared to those countries, which follow the policy of inflation targeting.
The present Chairman, Alan Greenspan (due to retire on January 31, 2006) is reported to be of the view that the Fed can control inflation without announcing a target rate. He thinks that an announced target would make it difficult for the US Federal Reserve to act in a flexible manner in a crisis. However, his nominated successor Ben S. Bernanke (who is a supporter of inflation targeting) had expressed the view that a transparent Federal Reserve policy (indicating the inflation target rate) could be more helpful in promoting non-inflationary economic growth. This, he believed, would give the business community and consumers certain knowledge about the future course of interest rates and inflation. Bernanke argues that in the event of a crisis, the Fed would do whatever it requires to stabilise the economy and no one would blame them for doing so.
So far as Pakistan is concerned, we have been fixing inflation targets for forthcoming years since long, at the time of the announcement of our federal budgets. All possible efforts are then made by the government to see that inflation does not exceed the target fixed for it. Monetary and fiscal policies are used and all other necessary measures are taken to achieve the aforesaid objective.
In Pakistan, double-digit inflation rates have always been viewed with concern. Considering that nearly one-third of the country’s population lives below the poverty line, independent economists have been of the view that inflation rates should be at the lowest possible level. In the US, 1 to 2 per cent inflation is considered reasonable. Since a much higher GDP growth is needed to deal with the problems of unemployment and poverty facing the country, the inflation rate may have to be a little higher - say up to 5 per cent. However, inflation rates higher than that would surely hit the poor and the people belonging to fixed income categories. Besides, higher inflation would, also, jeopardise our exchange rate stability and exports, which are crucial for a rapid and sustained economic growth.
The policy of inflation targeting has, at times, been criticised by economic analysts on the grounds that inflation is not always the result of an increase in the volume of money and credit. Due to the aforesaid reason, raising the interest rate cannot always control inflation. If inflation is the result of other factors such as increase in the international oil prices or less production of wheat or sugar in the country, raising the interest rate could do more harm than good to the economy.
The experience of Pakistan shows that inflation in this country has often been the result of factors other than an increase in money supply. For example, prices of certain commodities go up before the announcement of the federal budget, due to pre-budget speculations. In July/August, prices often come under pressure due to interruptions in supply resulting from monsoon rains and floods. Prices of certain commodities register increase on the eve of the holy month of Ramadan, because of a rise in consumer-demand for these items on the aforesaid occasions. In addition, inflation in Pakistan is often the result of hoarding, profiteering, smuggling and monopolistic tendencies. In all such cases, there is little that the State Bank can do to bring down the prices. The correct course for the government in all such cases would be to study a particular situation, identify the cause/causes of the price increase and then take necessary measures to remove the causes.
However, sometimes we come across a situation which is of a mixed nature and where increase in the volume of money and credit is, also, partly responsible for the inflationary pressure. An instance is the inflationary situation witnessed in the country during the last one to two years. The increase in prices, in this case, was attributable to a multitude of factors such as liberal credit facilities, more disposable income from remittances, speculative hoarding and profiteering, smuggling of wheat across the borders, effect of cost-push inflation, lack of government control on monopolies and cartels, corruption and so on. Since increase in the volume of money and credit was thought to be behind the hoarding of wheat and speculative investment in stocks and real estates, the State Bank of Pakistan (SBP) had raised the bank rate and resorted to open market operations to mop up excess liquidity.
In the same way, to deal with real and artificial shortages of items of daily use, the government had allowed duty-free imports of essential commodities. This helped in bringing down inflation from over 9 per cent last year to 8 per cent during the current year.
However, unless the government takes determined action to deal with hoarding, profiteering, smuggling, speculation, corruption, power enjoyed by the monopolies and cartels in the country and the problem of poor governance, inflation can not be fully brought under control.
Even if the government takes action on all the above-mentioned fronts, inflation rates are likely to remain a little bit higher, due to higher international crude oil prices. However, the level of inflation in Pakistan would then be comparable with the level of inflation in other countries of the region such as China and India.
It may be concluded that the concept of inflation targeting may be relevant in the context of Pakistan only in so far as an inflation rate (preferably below 5 per cent) may be fixed on an annual basis and, thereafter, all possible efforts are made to keep it within target. This is necessary because the current rate of inflation at 8 to 9 per cent, if not controlled, may jeopardise the macro-economic stability achieved by the country in recent years.
-The News International
posted by zaicha | Tuesday, December 06, 2005
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