Tight monetary policy hurts private sector: PIDE conference

The tight monetary policy stance through increase in the discount rate serves little to tame the inflation in prevailing situation instead it squeezes the private sector and discourages investment. The paper titled "Price Puzzle and Monetary Policy Transmission Mechanism in Pakistan," presented here on Tuesday at the Annual Conference of Pakistan Society of Development Economist (PIDE) stated that Pakistan has been witnessing unprecedented high inflation.
And tight monetary policy to counter the inflation has been crowding out liquidity to the private sector, which is facing extremely difficult situation. A tightening of monetary policy generally is expected is reduce the price level and not increase it but the response of prices to monetary policy shocks is sometimes contrary to economic theory. Explaining this situation, former Advisor to Ministry of Finance, who presided over the session, said that problem was on supply side and solutions should also come from there.
All the central bank has been doing, he said increasing the discount rate to tackle the problem and consequently the cost of inputs, capital, energy and raw materials increases. The increase in the input price was resulting in high cost of output leading to inflation. The government borrowing from the central bank was another reason for inflation and Ministry of Finance borrowing must be restricted.
The paper stated that high inflation reduces growth by reducing investment and productivity growth and monetary policy is one of the important tools with the monetary authorities to achieve the objectives of price stability. The response of prices to a monetary policy shock is sometimes contrary to economic theory, known as price puzzle. When monetary policy shocks are identified with innovation in the interest rate, the responses of output and money supply are correct, as a monetary tightening (an increase in interest rate) is associated with a fall in the money supply and output.
However, the response of the price level is wrong, as monetary tightening is associated with an increase in the price level rather than decrease. It has been observed that both interest rate and rate of inflation in Pakistan are rising during current decade and they have strong positive correlation. If rise in interest rate follows rise in price then we face price puzzle.
Another paper presented during the session drawing a comparison between conventional and Islamic banks in Pakistan, showed that in a very short time Islamic banking assets showed a massive growth of 6.1 per cent. The investors are willing to invest in Islamic banks due to its strong governance structure. The banking sector in Pakistan enjoyed healthy returns and achieved high growth after making necessary adjustment in their corporate structure.