It is generally believed that any country's economic growth has a close relationship with inflation. A high-level of inflation or acute deflation can hurt growth while moderate level of inflation is more suited to the growth rate of an economy. To test this hypothesis, research scholars in the State Bank of Pakistan have written a paper on "Threshold inflation in Pakistan" which proves that inflation below 5.67 percent may be favourable for economic growth but above 6.05 percent can hurt growth. In other words, inflation has a non-linear relationship with growth, ie, it affects growth positively when it is low and stable, and negatively when it is high. The authors have used two different methodologies covering annual data from 1976 to 2017 and found very close results, ie, 6.05 percent and 5.67 percent. Keeping in view close threshold inflation levels, the authors concluded that inflation below 5.67 percent may be favourable for economic growth and inflation above 6.05 percent can hurt economic growth. Historically, average real GDP growth rate has been more than 5 percent in Pakistan during the low inflation periods (ie, below 6 percent) and 4.7 percent during high inflation (ie, above 6 percent). However, there was one year (FY1990) when inflation was exactly at 6.0 percent and average real GDP growth was recorded at 4.6 percent - lower than its historical average. Besides, authors have found a number of years when high inflation and high growth coexisted and similarly low inflation was observed in the periods of low growth. Therefore, the authors have concluded that it was a difficult task to find threshold inflation in Pakistan and a more careful policy was required when inflation crosses the threshold level.
We have found the above study very interesting and revealing and the one that could be used for monetary policy purposes. Although it is difficult to exactly quantify the relationship between inflation and growth in various countries, a kind of guidelines provided by the authors in the State Bank could help the monetary policymaking body of the SBP to have a rough idea of the direction of policies to be undertaken to spur economic activity in the country and this is a great addition to the knowledge on the subject. The study has clearly demonstrated that monetary, budgetary and exchange rate policies need to be urgently employed when the inflation tends to exceed 6 percent or so for promoting growth. Also, the government authorities need to be apprised of the situation and taken on board to do the needful when required. Clearly, a more careful policy was required, both on the part of the government and the State Bank, when inflation crosses the threshold level of 6.0 percent.
However, while it is true that inflation and growth have a close relationship yet it cannot be forgotten that both these variables are also affected by a number of other developments. For instance, from 2014-15 onwards the rate of increase in the CPI has remained at 4.5 percent or below. In 2015-16, it even came down to below 3 percent. The growth during these years was not phenomenal and the pronounced decrease in inflation was due to low domestic food prices, an overvalued exchange rate of the rupee and depressed oil prices in the international market. Similarly, the growth rate in Pakistan is not only influenced by the level of inflation but by factors like weather conditions, availability of credit and needed inputs at the right time, law and order conditions in the country and situation at the borders. As such, the relationship between inflation and growth may not be very direct and exactly quantifiable but subject to certain other factors. Hopefully, the authors of the study are aware of all these constraints and imponderables and would continue to make further efforts to improve the model for the benefit of all those involved in formulating monetary policy.