The central bank has failed to tackle supply-side inflation


Are Pakistani interest rate hikes already high enough to push the economy into a recession? The answer, probably yes, because over the past two months the slowdown has been quite noticeable.
The con delayed by more than half in December 2021, while the SME sector is in any case in sharp decline since the fourth quarter of 2021.
However, this is a question on which economic and central managers generally consult each other to determine where to set the bar with interest rates to avoid the danger of recession. Ironically, in Pakistan, after the central bank reforms, this decision was rather one-sided. For example, Yellen only recently chaired a debate about how high interest rates can go without tipping the US economy into a recession.
Unlike in Pakistan, this has been the debate that has agitated economists who decide the Federal Reserve’s monetary policy. Crucially, the outcome of those meetings or debates doesn’t end up being vague either: so far, the Federal Reserve has committed to raising rates — perhaps seven times — this year to cool prices.
The decision facing Federal Reserve officials is how difficult it is to step on the brakes. In its latest “Summary of Economic Projections”, the official document suggests 12 rate hikes this year while indicating that there will be at least five for sure (in total 3% of the total hikes for the year against 1, 25%). For markets and companies, clarity is always the most important element, while uncertainty kills. Now, no marks to guess which direction policymaking is leaning here at home!
The fact is that changes in interest rates alone do not create more semiconductor chips, build more houses, or increase production in the supply chain pipeline. But raising rates may slow economic activity enough to ease the inflationary pressures that are currently squeezing Pakistani wallets. In February, inflation hit almost 13% (official figure, although in reality it could be much higher) on an annual basis, according to the consumer price index, with no real idea of ​​​​what could really be the culmination of this unprecedented inflationary rise in the country. the history of Pakistan or are we already falling into a trap of stagflation.
The decision facing our central bank is how far to press the brakes. Yet how much these interest rate hikes will affect inflation and economic growth remains unclear. The reason for this is that higher interest rates will not solve the underlying drivers of current inflation: primarily commodity shortages and supply chain failures. In the 1970s, a similar type of inflation was driven by wages, prices chasing each other and mainly currency devaluation – a problem that some say is related to the current phenomenon and could again get out of hand today.
Recently, Steven Kelly, associate researcher in the Financial Stability Program at Yale University, argued that steady gradual rate hikes show that a central bank is simply trying to lower inflation with monetary tools, so that the reality on the ground could be very different; one that is more tied to world events (Covid pandemic and now Ukraine war or simple erosion of perception and trust).
Needless to say here, these rash increases in a country’s interest rates could end up jeopardizing not only its long-term growth sustainability, but also run the risk of pushing it into a vicious financial cycle where any increase in outlook future growth may become meaningless or will become irrelevant simply because its very underlying ability to service external debt will no longer remain commensurate with the total market base it holds – lately, Events in Sri Lanka give us some clues about such a situation.
Ironically, this is also exactly the kind of risk or danger that Pakistan faces today, unless we quickly remedy the situation and find the right balance in our monetary policy and fiscal spending to prevent a fall of the Pakistani rupee which could tip the country into the dark ages. .
How do interest rate hikes affect the economy? In a nutshell, higher interest rates reduce household and business borrowing and spending. When the central bank raises the interest rate on the money it gives to the banks, the banks raise their own rate for loans on everything from car loans to mortgages to loans.
As a result, companies are investing in fewer projects, hiring fewer people and limiting wages. Consumers then spend less and repay their debts. For investors, a higher federal funds rate reduces the overall market value of Pak Currency or securities or bonds (if in rupees), which means investors who hold a lot of treasury bills – usually savings – will have to sell other parts of their portfolio to rebalance their losses and make them less likely to invest in new, riskier ventures. As innovative investments plummet, so does the country’s long-term fortunes.
So why would the central bank want to raise interest rates? For the past year, the price of durable goods such as cars and furniture has been fueling inflation thanks to the rise in the cost of raw materials. Today in Pakistan, the central bank is worried because inflation is indeed spreading to basic food items, basic health care, services, housing and rents, while the prices of goods sustainability continue to increase (the original target).
In the last half of 2021, unfortunately, inflation rose as a general undesirable instead of being confined to specific sectors, which economic managers must have thought could be brought under control by monetary policy – services represent on average 57% of the consumer price index, while rents are rising by 33%, so they must have thought that if these could be brought under control, headline inflation would eventually slow on its own . Obviously that didn’t happen.
The problem now is that prices for food, housing, health care and rent are more sticky and show up in economic reports later than the other items. This means that the moment the Fed sees inflation rise above current unsustainable levels in these categories, it will pose a danger to the very contract between the state and its people. The fear is that it may be too late, especially when national leaders are busy playing musical chairs!

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