Monetary Policy Needs Softening |
In its recent meeting, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has decided to reduce the policy rate by 50 bps to 10.5%, effective from 16th December 2025. Two and a half years back, in a reaction to a record high inflation rate of 29.2%, the MPC had resorted to an all-time high policy rate of 22%, effective from 27th June 2023. After the usual monetary policy-specific time lags, the inflationary tempo started experiencing a gradual deceleration, and consequently, after a year’s interval, the restrictive stance of monetary policy has been periodically relaxed. Our holistic assessment, to be elaborated hereafter, of key developments in the macroeconomic scene over the last two and a half years is that, despite many periodic reductions in the policy rate over the last one and a half years, the policy rate is still restrictive. Once its objective has been achieved, its continuation is not compatible with the situation when the recovery in the economy is fragile and the government has initiated a process of implementing a wide agenda of reforms. This analytical brief will discern some insights from Pakistan’s short-run experience of using inflation-targeting monetary policy to control inflation in a recession.
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The monetary policy is basically a demand management policy and cures only the ills originating from excess demand. The spike in inflation had spurted mainly due to cost-push factors, supply shocks, and inflation expectations. These forces were partly fuelled by non-economic factors like political uncertainty, law and order, and the geopolitical environment. Demand management policy was a misfit prescription. Such an inflationary spurt is a one-off phenomenon and disappears in the short run. Since maintaining price stability is the function of the State Bank of Pakistan (SBP), this........