A working paper by a four-member research team of the central bank has come out with a critical appreciation of the efficacy of monetary and fiscal policies in combating recessionary trends and putting sagging economies on the path of sustainable growth.
The observations/conclusions reached by the researchers in some ways deviate from the dogmatic approach. It tends to question the legitimacy of the universal application of prevailing dominant ideas while remaining within the ambit of the space provided by the paper`s topic: `The Borrower Syndrome: The case of Pakistan`.
The significance of these contrary views lies in that they come from the ` belly` of the central bank itself. The working paper acquires more relevance as it questions worldwide efforts to increase growth rate with once tried and tested tools that seem to have lost at least some, if not much, of their utility in these turbulent times.
The authors of the working paper are: M. Ali Choudhary, Farooq Pasha, Muhammad Rehman and Sajawal Khan.The research report tinkers with orthodoxy the fiscal stimulus and money easing as a sure recipe for economic growth with the following remarks: `the extraordinary monetary measures taken on the onset of the (2008 Global Financial) crisis may have averted a collapse but their effectiveness to deliver sustain-able growth leaves much to be desired … the international experience on the effectiveness of an expansionary fiscal policy does not bode well either.
But perhaps a no less pedinent observation centres round the application of even valid universal ideas in different stages of economic development and the varying cultural background of different countries.
The report quotes llzetzki, Menoza and Vegh (2013) who have shown that `for developing countries the fiscal multiplier is negative: output declines in response to an increase in fiscal spending` The researchers` findings suggest: `too many expectations from the fiscal stimulus would be an error in emerging economies with limited resources and a developing financial infrastructure.
The research focuses and analyses the consequences of the government emerging as the commercial banks `dominant borrower` in Pakistan with its own `possible malaise`: widening of interest rate spreads; lower credit offtake by private sector despite cut in policy rate from 10.5pc to 6pc over the past four years; reluctance of commercial banks to intermediate because of supply of zero-weighted assets (government papers); and a weakening transmission of monetary policy.
As a result of rising government borrowings,the report says, the increase in output is smaller and shoher as compared to the increase in inflation. This does not support theidea that fiscal expansion is noninflationary if financed by commercial banks instead of the central bank.
The report recalls that increasing government borrowings from commercial banks followed the IMF 2008 programme, with the understanding that the borrowings from the central bank were more inflationary. However Pakistan is not alone in suffering from the dominant borrower syndrome.
The researchers have extended the Melina and Villa (2014) model to allow the government to compete with private borrowers (firms) for bank credit in a `monopolistically competitive banking industry` but reached different conclusions. They differ from foreign scholars in that the increase in government spending leads to a spurt in growth and that a counter cyclical interest rate spread is the result of this expansion.They hold the view that in case of monetary shock, credit to the private sector falls due to the high cost of borrowing, and in turn output and inflation fall below their respective steady states. Government revenues fall due to a reduction in national income. Impulse responses show that the impact of monetary shock on all variables lasts for a longer period of time.
The central bank`s experts` maintain that fiscal deficit is counter cyclic because in the recessionary period tax revenues shrink and government expenditure continues to mount. The government borrows from commer-cial banks because of limited access to foreign credit in bad times; borrowings from central bank are more inflationary and increasing taxes unpopular. As a result, the interest rate spread increases and private investment decreases. This makes the recessionary phase deeper, and last longer, than it would have otherwise.
While noting that the government had no recourse to other sources but to borrow from commercial banks in order to finance its fiscal deficit, the study argues that an increase in consumption tax rate would be a better policy choice to finance expansion in government spending, especially during recessionary periods.
The researchers argue that the eventual impact of fiscal expansion on the aggregate economy depends on how the funds to finance this expansion are raised, in addition to where these funds are spent.
By its very nature a working paper provides room for considering various aspects negative as well as positive of any policy under review or under formulation. Conceding that it is still encouraging to note that institutions like the State Bank of Pakistan and the International Monetary Fund are now more open to contrary views within their organisation, such views may still take some time to filter and permeate the realms of policymaking.Nevertheless these difficult times are fuelling new ideas whose time has come.