Dealing with inflation during the pandemic

The IMF must also issue SDRs

‘With Western economies battered by COVID-19 and central banks running out of ammunition, fiscal policy is the only game in town. This should be openly acknowledged, and fiscal rules should be rewritten to allow for more active counter-cyclical policy and a much larger government role in allocating capital.’ – excerpt from a recent Project Syndicate published article ‘The silent revolution in economic policy’ by Robert Skidelsky

While the above is with regard to western economies, with far greater developed financial sectors, the same is even more important for developing countries, especially recession-hit economies during the pandemic, where inflation is at least equally a fiscal/governance-related phenomenon. For developing economies like Pakistan, which are also net importers of oil, with substantial dependence of the transport and energy sectors on oil, having significant scope for inflation pass-through from the exchange rate channel, and with import bills containing a heavy chunk in terms of products related to the agricultural sector, the rise of oil- and food nationalism have built in strong inflationary spirals going forward. Add to this the heavy import bill, in the coming months and even years, in terms of vaccine purchase for a big population, will all have important bearing on upward push of inflation, especially given the strong presence of vaccine nationalism, and high patent walls for vaccine, both keeping prices of Covid vaccine on the higher side.

Having said that, being a developing economy with relatively much smaller level of financialization of the economy than in developed countries, and if repeated experiences of macroeconomic management in the country in the past are not to be ignored, then inflation should be tackled as both a fiscal and monetary phenomenon, since inflation in developing countries like Pakistan is at least equally a fiscal/governance-related phenomenon. This revision in traditionally monetary-loaded approach for tackling inflation is all the more important, given strong recessionary impact of pandemic on the economy— likely to push many below the poverty line, not to mention the general negative impact on businesses and employment– whereby the usual neoclassical/neoliberal recipe of treating inflation as primarily a monetary phenomenon, and targeted in a lopsided way, demanding unwarranted economic growth sacrifice for most probably short-lived macroeconomic stabilization.

While repeated recourse to this policy prescription has had only very limited and short-lived impact on curtailing inflation in the past, and has had severe negative economic consequences in terms of growth and poverty levels, any push from International Monetary Fund (IMF) – especially when Pakistan is currently under its programme – or from the ‘Chicago boys’ policymakers supporting the same austerity policies as in the past, would likely have dire consequences for the economy and poverty, already hit by recession; which requires stimulus– including significant and targeted subsidies– and greater governance/fiscal policy interventions for controlling inflation, than excessive use of the policy rate instrument.

In addition to understanding the importance of relying more on fiscal policy, than on monetary policy to curtail inflation, especially in developing economies during the pandemic, and at least equally, in times when there is no recession, IMF should also look to allocate an enhanced level of Special Drawing Rights (SDRs). This would help allay balance of payments pressures on developing countries, who need to balance higher inflationary induced significantly from the phenomena of triple nationalism – vaccine, oil, and food – and meeting stimulus needs for reaching healthy economic growth rates.

At the same time, interest rate hike argument to induce portfolio investment, in addition to the misguided overuse of the policy rate instrument in tackling higher rates of inflation, should not be used to attract very fluid, hot money, at the cost of great misery in the real sector. Here, the cost of adopting this path of building foreign exchange reserves should also internalize the negative impact on overall fiscal space in the country, especially at a time when greater stimulus and health sector related spending needs exist during the pandemic, in terms of increased interest payments on an already high level of domestic debt; especially after months of needed stimulus/welfare, and health sector related spending.

In the same article by Robert Skidelsky, while the need for understanding the importance of the role of fiscal policy was highlighted for western economies, all the more of the same is applicable for emerging/developing economies given a relatively lot less developed financial sector and overall greater governance issues facing economy. In this regard, he pointed out ‘Before the 2008-09 crash, many believed that macroeconomic stabilization was entirely a matter for monetary policymakers, and should be carried out by independent central banks targeting a mandated inflation rate by means of interest-rate policy. This followed from the orthodox belief that economies were cyclically stable, provided that inflation was controlled. Fiscal policy should be passive, or even contractionary if spending cuts would boost market confidence. The belief in the superiority of monetary policy survived even the savage 2008-09 downturn.… Although the combination of monetary expansion and fiscal contraction failed to bring about the expected recovery, belief in monetary therapy was still strong when the COVID-19 pandemic struck in 2020. … In fact, the outstanding feature of Western governments’ responses to the pandemic was their untargeted character. … In the absence of stimulus, the post-COVID European and US economies are expected to have shrunk in 2020 at the highest rate since World War II, with a concomitant rise in unemployment.’

In addition to understanding the importance of relying more on fiscal policy, than on monetary policy to curtail inflation, especially in developing economies during the pandemic, and at least equally, in times when there is no recession, IMF should also look to allocate an enhanced level of Special Drawing Rights (SDRs). This would help allay balance of payments pressures on developing countries, who need to balance higher inflationary induced significantly from the phenomena of triple nationalism – vaccine, oil, and food – and meeting stimulus needs for reaching healthy economic growth rates.

In this regard, the current IMF programme with Pakistan should be revised to accommodate the greater role of fiscal policy. Moreover, the IMF should look to enhance its allocation of SDRs to the tune of at least $500 billion for its member countries, at the earliest possible.

Dr Omer Javed
Dr Omer Javed
The writer holds PhD in Economics degree from the University of Barcelona, and previously worked at International Monetary Fund.Prior to this, he did MSc. in Economics from the University of York (United Kingdom), and worked at the Ministry of Economic Affairs & Statistics (Pakistan), among other places. He is author of Springer published book (2016) ‘The economic impact of International Monetary Fund programmes: institutional quality, macroeconomic stabilization and economic growth’.He tweets @omerjaved7

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