‘This chapter has shown that the NMPC [New Monetary Policy Consensus] is limited in four important ways. Firstly, it is based on doubtful assumptions, unwarranted generalisations, overly optimistic expectations about convergence to a virtuous circle of prosperity, and the questionable ability of neoliberal policies to extricate the economy from finance-driven crises. Secondly, the NMPC imposes low inflation targets that can lock the economy into a pattern of low growth, high unemployment and potentially intractable problems of poverty and inequality. Thirdly, it offers only blunt and inefficient policies against inflation, grinding it down through potentially long periods of high unemployment that reduce the economy’s growth potential while increasing its financial fragility.
Fourthly, hyper-vigilance against inflation, which is built into IT [inflation targeting] and CBI [central bank independence], is incompatible with rapid and equitable growth, because it fosters the interests of finance at the expense of the majority of the population and locks countries into economic development strategies that are inimical to the achievement of democratic outcomes… Given these limitations, why does the mainstream place so much emphasis on IT and CBI, as is demonstrated even by a cursory perusal of IMF [International Monetary Fund] publications and the writings of most mainstream macroeconomists? Several contributing factors can be readily identified.
First, mainstream theory is structurally predisposed to see value in IT and CBI, since they share the same methodological foundations …Second, IT and CBI are hegemonic under neoliberalism. They have become part of the ‘common sense’ of the age, and these policy recommendations tend to creep unthinkingly into even heterodox discourse.’ – An excerpt from Chapter 26 ‘Monetary policy and Neoliberalism’ published in a 2018 ‘SAGE’ published book ‘The SAGE handbook of Neoliberalism’
It is well established in economic literature, and in empirical studies researching determinants of inflation in developing countries, including Pakistan, that in general it is at least equally determined by aggregate supply-side determinants, and not predominantly by aggregate demand-side.
In general, it is witnessed in the case of not only a number of developing countries, but also developed countries, that not only inflation remains stubborn even when policy rate is increased to high levels, meaningful and sustainable drop in inflation requires high level of positive real interest rate – as has been the case in Pakistan – which means that on one hand monetary austerity is being overused, while aggregate supply side focus remains limited in controlling inflation, and on the other as a consequence a lot of economic growth sacrifice is unnecessarily given.
For instance, even when policy rate was being raised inflation was rising in Pakistan – due to higher policy rate contributing to higher cost-push inflation on one hand, and larger burden of interest payments on debt bringing in greater imported inflation on the other hand – not to mention increasing debt unsustainability, and enhancing pressure on fiscal deficit – since depletion of foreign exchange reserves as a consequence of higher interest payments on external debt due to same neoliberal-minded policy being practiced internationally in general leads to depreciation of domestic currency, making, in turn, imports more expensive – inflation continued to rise since a major determinant of it was both domestic aggregate supply traditional-natured weaknesses, and international-level aggregate supply shock in the wake of the Covid pandemic.
Moreover, even when policy rate was above a high of over 20 percent that inflation continued to remain stubborn, while currently while inflation is a little more than 4 percent, policy rate is still 12 percent.
Hence, it was only after the supply shock internationally somewhat went away, and aggregate demand got heavily squeezed that inflation started to come down, but as usual this is no sustainable fall, given as monetary- and fiscal easing will follow the same over-heating of economy, and alarms of balance of payments crisis will come running back as needed reforms on the aggregate supply are not being carried out meaningfully. Moreover, even as reforms are hopefully carried out, greater role of fiscal policy can allow much lower application of austerity policies.
It has clearly been indicated time and again, not just in developing countries but a number of times even in developed countries – like the experience of Spain in the wake of the pandemic, and especially as the global supply chain crisis took deeper footing – that targeted price control policies and greater and more innovative fiscal policy measures were taken to remove bottlenecks to enhance the productive- and allocative efficiency on the aggregate supply-side, all requiring less of aggregate demand squeeze policies – as otherwise prescribed by widespread practice of neoliberal policies, which is also the bread-and-butter policy basis of multilateral institutions like International Monetary Fund (IMF) – and in turn avoided sacrificing a lot of economic growth with positive consequences that come with minimal practice of austerity policies in the shape of mainly lower unemployment rate, reduction in poverty, and even improvement in the political voice where the latter brings advantage of greater activism of demos pushing through otherwise difficult legislation in an economy of elite capture – as has been the case in many developing countries and even in more and more developed countries overall under the neoliberal assault of the last four decades or so – like taxing the rich, or broadening the tax base.
Among arguments that are given in favour of using mainly the monetary policy tool – or, in other words, employing monetary austerity where austerity policies as a whole may also include adopting fiscal austerity policies like targeting primary surplus – to reduce inflation includes foremost, and as Milton Friedman puts it ‘inflation is always and everywhere a monetary phenomenon’.
As indicated above, this not only not hold in developing countries, but under the assault of neoliberal policies has also come to increasingly become relevant for developed countries as under ‘market fundamentalism’, price signal, and predominantly short-term profit mindedness has not allowed economic resilience, including resilience of global-, and domestic supply chains. This in turn has meant inflation is sustainably reduced through a much more balanced application of aggregate demand-, and supply-side policies.
Hence, inflation is not just primarily a monetary phenomenon, but also significantly a fiscal/governance related phenomenon, meaning whereby in addition to reining in the use of policy rate, it is important to take fiscal measures in a more pronounced, and innovative way, to include better reforms to improve economic institutional quality, underlying organizational efficiency, and much better price discovery in markets.
The latter set of reforms, moreover, needs to be seen in a multifaceted, political economy way, where political economy is not wrongly viewed as interaction of politics and economics, but the term means seeing economy through multisectoral interactions, especially in the wake of fast-unfolding climate change crisis, those from environment, and epidemiology.
Also, this multifaceted approach requires moving away from seeing a very limited and mostly exogenous role of institutions in economy, as seen under Neoliberalism, but to see an active role of institutions in reducing transaction costs and reaching better price discovery. On the contrary, reform policy, in particular the policy to improve economic resilience, reduce inequality and poverty, and improve political voice needs to seek guidance from both the traditional institutional economics, and more recent heterodox-oriented new institutional economics to give direction to institutional reforms by mainly focussing on reducing transaction costs and instead of following market fundamentalism, involving appropriate level of hierarchy in markets, and overall employing governance- and incentive structures that enhance productive- and allocative efficiency that has a greater policy, and active partnership footprint of government.
As a corollary, this does not mean having worry of more or less government, but rationalizing the role of government to create more resilient economy, especially to restore economic decision more in line with socially responsible decision, especially to meaningfully check the fast-unfolding of climate change crisis, and the associated ‘Pandemicene’ phenomenon.
A question has also been raised, especially in developing countries, with generally weak aggregate supply-side both in terms of sub-optimal domestic production and low level of exports as how to safeguard savings, and foreign portfolio investment (FPI), on one hand, and from ending up over-heating the economy, especially on the side of balance of payments by not employing policy rate as the main tool in not only reducing inflation but even in times of low inflation to keep it much higher than inflation rate – as currently is the case in Pakistan – to apparently attract savings and FPI.
Moreover, policy rate has also been kept on a higher side to avoid boosting of import demand in an overall effort to safeguard depletion of foreign exchange reserves and, in turn, to keep from depreciation of the domestic currency, especially against the US dollar.
Time and again, instead of building up the aggregate supply-side, which is an active source of inflation, policy rate is being over-used to squeeze aggregate demand to curtail inflation. This neoliberal-minded macroeconomic policy needs to stop, particularly the over-riding influence of monetarist school of thought, and NMPC, both of which have strong overlapping with Neoliberalism.
In particular, neoliberal monetary policy needed to stop many years ago, and hence it has been long overdue that should be replaced with a macroeconomic policy that approaches inflation reduction from both aggregate demand-, and supply-side in a more balanced way, so that unnecessary economic hardship is avoided, which comes as a result of practice – for instance, the negative consequences of austerity in eurozone after the Global Financial Crisis 2007-08, and the repeated economic hardship in developing countries over the last many decades, strongly under the influence of local policymakers, who act as Neoliberalism-minded ‘Chicago boys’, and under same neoliberal policies that these countries undergo as IMF programme countries.
This is because this neoliberal minded policy hurts economic growth, increases unemployment, enhances inequality and increases poverty in view of the fact that the burden of austerity policies has a negative correlation with individuals falling in higher income groups due to the underlying regressive taxation policies, and greater capacity of people already in higher income groups to better bear the increasing cost of capital.
Instead, policy rate needs to be coupled with greater role of fiscal policy in terms of better incentive structures like progressive taxation, and enhanced (but more targeted) subsidy policies, greater administrative controls on imports, and channeling consumption into more productive avenues by creating positive-, and negative incentivization.
Moreover, in the spirit of moving away from Neoliberalism, policy rate is not used to lure FPI but greater foreign direct investment is created by better governance- and incentive structures to create more inviting aggregate demand- and supply-side – in terms of better investment and consumption decision making in order to reach more productive- and allocation efficiency – for both domestic- and foreign investors.
Such incentivization will also allow reaching better savings decisions since they will have more competing returns on saving and investing, which means that even at lower interest rates, people will only save if they find no place to invest, which will be a much more difficult choice under better incentivization by policy that has improved a lot economic institutional quality, and underlying organizations and markets.
Copyright Business Recorder, 2025