Another hike

The central bank raises the discount rate once again

If all you have is a hammer, all problems will look like nails. And the central bank does seem to have a hammer in the shape of interest rates hikes. In its latest Monetary Policy Statement, the State Bank of Pakistan (SBP) announced a 100 basis point hike in the policy rate to 17 percent, citing persistent inflationary pressures and the need to anchor inflation expectations. However, it’s important to note that the recent bout of inflation is mainly driven by cost-push factors such as rising commodity prices and a depreciating rupee, rather than demand-pull factors.

The SBP’s decision to increase interest rates in the face of these cost-push inflationary pressures may not be effective in bringing down inflation in the long term.

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It’s also worth noting that the interest rate hike may come at the cost of further slowing down economic growth. The SBP’s statement acknowledged that economic activity is already moderating in response to policy tightening and exogenous shocks, such as the recent floods. The production of automobiles, POL, and cement has declined significantly, and the large-scale manufacturing output has decreased by 5.5 percent in November 2022.

In light of these developments, the SBP should consider alternative policy measures that address the underlying causes of inflation, such as exchange rate stabilization and increasing exports, rather than relying solely on interest rate hikes to curb inflation.

The SBP’s decision to increase interest rates is understandable given the current inflationary pressures, because it seeks to ‘anchor’ inflation around a particular range of percentage. It seeks to exercise power of that end of the problem that it does have agency over. And, as some economists point out, even cost-push inflation can lead to demand-pull inflation: consumers stock up on some purchases in anticipation of price hikes. Neoclassical economics centres around the management of expectations; the central bank’s interest rate hikes aren’t as hamfisted as they appear.

Still, it is crucial to remember that it may not be the most effective solution in the long-term. The government should focus on addressing the root causes of inflation and supporting sustainable economic growth.

The Editorial Department of Pakistan Today can be contacted at: [email protected]


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