As another monetary policy statement is about to be released, as the writer contributes this article, it is time to indicate why it is very important that it is over-due that over-board monetary austerity is reined in significantly.

This is because in view of the fact that both traditionally a significant role of supply-side, governance-related policies in determination of inflation in developing countries, including Pakistan, the aggregate supply-shock in the aftermath of Covid pandemic – and exacerbated by the war in Ukraine, especially in terms of food and energy supply constraints pushing up their prices all the more – made this channel of inflation all the more relevant.

It is important to note that unjustifiably excessive reliance on increasing policy rate to bring down inflation through squeezing aggregate demand has backfired in the shape of built-up of strong stagflationary headwinds for the economy.

Here, it needs to be indicated that austerity in economics literature is used in terms of using monetary, and fiscal policy instruments – policy rate, taxes, and government spending, for instance – to curtail aggregate demand in the economy, and not in terms of bringing expenditure efficiency, especially non-developmental expenditure, which indeed should remain a policy goal.

The argument that real interest rate – nominal interest rate minus inflation rate – should be positive, while traditionally worked for advanced economies, with deep financial sector, and where in the wake of aggregate supply shock, justification for this has decreased to avoid ‘hard landing’ in terms of recession, and even stagflation, it has virtually no relevance for developing countries, especially during the current times as indicate above.

So, the ‘Chicago boys-styled’ policymakers in Pakistan are still calling for increase in policy rate, although it is very clear that instead of lowering inflation this is most probably contributing to inflation through the channel of cost-push inflation.

It needs to be indicated here that the underlying reason given by these neoliberal, Chicago boys- styled policymakers – both in and outside of the International Monetary Fund (IMF) – that a positive real interest rate is needed to safeguard, and even boost savings rate in the case of developing countries like Pakistan, are in turn most probably, harming savings rate.

This is because monetary austerity is increasing cost-push inflation, which in turn, is enhancing consumption expenditures, leaving in turn little for saving in the first place.

Moreover, raising policy rate increases government’s own expenditures in the shape of interest payments on domestic debt, which in turn, put greater pressure to increase fiscal austerity – increase domestic resource mobilization, on one hand, and reduction development expenditures, on the other.

Overall, in the case of Pakistan, like many developing countries – and even developed countries in a significant way since the global aggregate supply shock – both monetary- and fiscal austerity policies have resulted in a lot of growth sacrifice for little success in terms of reducing inflation, and that too over a very-short term.

Sadly, proponents of ‘basic economics’ or ‘sound economics’, these ‘Chicago boys-styled neoliberal policymakers remain apparently oblivious to the strong backlash against these ‘shock therapy’ policies, especially since the Global Financial Crisis of 2007-08, and especially in the wake of the austerity project in Europe during the last decade, and more recently in the lack of success of these policies to control inflation overall globally.

Instead, the focus of policies need to focus away from ‘market fundamentalism’ and austerity policies to a more balanced approach that allows for greater governance/regulation, more reined in aggregate demand squeeze policies, and which reduces supply-side bottlenecks, and over-profiteering.

In her book ‘How China escaped shock therapy: the market reform debate’, renowned economist, Isabella M. Weber highlighted that instead of following the usual bread-and-better mantra under neoliberal policies of allowing too much market fundamentalism, and sacrificing economic growth in an overboard way to reach some semblance of macroeconomic stability, China adopted a pricing policy of ‘dual-track system’ to positively constrain market fundamentalism so that growth is protected, and inflation is controlled through better outcomes in terms of aggregate supply – including that in terms of exports growth – and overall both lesser unemployment, and over-profiteering.

Dual-track pricing system in China is highlighted in her book as follows: ‘…is not simply a price theory, but rather a process of market creation and regulation through state participation. …In contrast, big bang price liberalization under shock therapy caused a disorganization of existing production links without replacing them with market relations.’ Hence, ‘strategic price controls’ were put in place for economic sectors that were important for the overall economy in terms of curtailing inflation, boosting exports, and fuelling economic growth.

Regarding the usefulness of adopting ‘strategic price controls’, Isabella and others in their research paper ‘Inflation in times of overlapping emergencies: systematically significant prices from an input-output perspective’ highlighted the need to move away from traditional macroeconomic toolkit of monetary- and fiscal austerity, to an ‘input-output setup’.

The paper pointed out in this regard: ‘We use simulations of price shocks in an input-output model to pursue an alternative approach to the view that inflation is exclusively macroeconomic in origin.

In policy debates, most economists have until recently tended to see inflation as a purely macroeconomic phenomenon: Monetarists as the result of “too much money chasing too few goods” and New Keynesians as a matter of the relation between aggregate demand and capacity utilization.

The key variables to control inflation from both perspectives are thus macroeconomic: the quantity of money and government spending. …By identifying the specific sectors that matter most for general price stability, we contribute to the on-going expansion of the toolbox of stabilization policies.

When faced with large sectoral shocks, it is not sufficient for monetary stabilization to rely on purely macroeconomic means designed to respond to demand-pull inflation. …[Instead] input-output setup, under an overall Leontief price model to the policy toolkit to control inflation [needs to be put in place]. …We simulate how in an input-output setup a price shock in any specific industry cascades as a cost shock through the whole system, leading to changes in the general price level. This means that we not only take direct effects of a price change on the consumer price index into account, but also the myriad of indirect effects that follow cost changes in other sectors.’

It is high time, therefore, that instead of subjugating the economy, time and again, through strong shock-therapy policies – under the overall mantra of sound or neoliberal economic framework, and wrongly indicating it to be ‘basic economics’ when it is not given the virtually always existing parallel field of ‘political economy’, non-neoliberal economics, both in terms of thought process, and through practical adoption by countries that therefore saved themselves in a big way to become the ‘third-world’ countries – which only provided at most temporary and limited macroeconomic relief, and that too at a very high growth sacrifice cost, and instead, move towards adoption of non-austerity policies.

Copyright Business Recorder, 2023