By: Hadisa Rafique Mughal
To address inflation through fiscal policy, a government can consider measures like reducing public spending, increasing taxes, or implementing policies that promote savings and investment. Adjusting the fiscal account requires a balanced approach to ensure economic stability.
There is a discussion about the fundamental causes of inflation and the efficacy of traditional tactics to combat it because global inflation has persisted despite extraordinary action by central banks. The idea that monetary policy is the only effective way to combat inflationary pressures is false; fiscal policy also plays a significant role in controlling inflation.
In my opinion, Pakistan’s fiscal policy is the primary cause of inflation. Reducing inflation requires addressing the structural deficiencies in fiscal policy. In The Fiscal Theory of Price Level, John Cochrane makes the case that “stronger fiscal-monetary policy will be needed to control inflation in light of the large debt and deficits, as the current inflation spurt appears to be clearly related to the massive fiscal expansion of the Covid-19 recession.” So fiscal policy correction is important to remedy inflation.
The prevailing notion of inflation targeting is irrational, he argues, and it provides central banks with no guidance should inflation or deflation materialize. This is an increasingly evident point of contention. The IS-LM [investment saving-and liquidity preference-money supply] intuition, which dates back to the late 1970s and has been expanded to explore expectations acting on their own, is the foundation used by central bankers. The new Keynesian models that have dominated academia for the last 30 years are not taken into consideration in their analysis. Narratives of great power and complex technical manipulation are presented, which deviate significantly from economic models or reliable empirical data.
The problem is that while private wealth is concentrated in a small number of hands, it is increasing together with our national debt. Pakistan requires a recalibration more than others, possibly because it is dealing with complex forms of conventional and unconventional inflation, such as debt-flation, shrink-flation, and greed-flation, which are symptoms of structural deficits and post-covid-19 pro-cyclical policies, as well as regional conflicts that are both communal and transnational.
When government expenditure surpasses revenue from taxes, there is a structural deficit. The main area of government expenditure balance where we are falling short of the IMF’s target of 0.4 percent of GDP is the structural deficit. But the soaring expenses of debt servicing are added to the principal balance. The cost of debt servicing rose to 74 percent in FY 2023 of FBR tax revenues, in FY2024 they are likely to rise closer to 90 percent.
In this situation, the sovereign’s inelastic demand for debt to cover its deficits has meant that using monetary policy as the only tool to control inflation has not only failed, but also proven counterproductive. Given the scarcity of available funding sources and the unavoidability of funding needs, the government does not adjust interest rates in order to finance its deficits. The significant fiscal deficits have essentially offset monetary tightening.
It’s difficult to collect taxes. However, it appears that the recent tax collection campaign, which included the prosecution of hoarders and smugglers as well as the decision to turn off utilities in the event that taxes are unpaid or if a taxpayer is not registered even though they have taxable income, is having some success. Regarding spending, the time has come to support public-private partnerships for privatization, pension management, and government-sponsored development initiatives.
Therefore, “debt-flation”—the increase in the money supply due to the government’s need to finance its deficit—is what is causing inflation. Due to global liquidity issues and downgrades in credit ratings by international agencies, external funding sources have dried up. In other words, the domestic banking sector is funding almost 95 percent of the fiscal deficit.
At present, there is a nearly 25 percent funding source for public domestic debt relative to bank deposits, which is primarily attributed to liquidity injections by the central bank. As of 2023, average inflation was nearly 4.5 times higher than the regional average, and it remained high at about 30 percent.
Diminution in short-term money obligation can’t be accomplished through rebuilding, as I have contended already. Any endeavor to rebuild obligations without updating the financial account will be short-lived and have grave results on the by and large economy. We can’t get carried away with brief interwoven, like neighborhood cash obligation rebuilding; presently is the time to require taking the bull by the horns, ie, monetary account rebuilding.
Based on economic redistribution, a “progressive social agenda of inclusivity and tolerance” ought to be implemented. Taxing the extremely wealthy and tax-exempt industries of real estate, retail, and agricultural should be the first step. Perhaps this crisis presents the finest chance for us to address these shortcomings. The handy notion of “trickle-down” programmes has to be dispelled. The wealthiest will continue to get untargeted subsidies and tax breaks, which will further exacerbate the inequities.
It’s difficult to collect taxes. However, it appears that the recent tax collection campaign, which included the prosecution of hoarders and smugglers as well as the decision to turn off utilities in the event that taxes are unpaid or if a taxpayer is not registered even though they have taxable income, is having some success. Regarding spending, the time has come to support public-private partnerships for privatization, pension management, and government-sponsored development initiatives.
