Monetary policy is not the best tool

Recently, the State Bank of Pakistan announced a 100 basis points hike in the policy rate to 16 per cent, against the market expectations of the status quo. It was done in response to the inflationary pressures, which have been proven to be stronger and more persistent than expected. For too long, we have relied solely on monetary policy to control demand and inflation to cool down the heated economic activities. However, the inflation we are facing is rather cost-push inflation which is not effectively addressed by monetary policy. Short-term yields are already close to 16pc, which indicates that the hike is already priced in by the secondary market. Thus, the impact of monetary tightening should stay muted as yield might not surge a lot. But let’s assume yields will also increase by 100bps in response to the monetary policy decision. In my opinion, this monetary tightening (and probably more to come) might yield some fruits to reduce pressure on external fronts but at the cost of a higher fiscal deficit.