Tackling inflation with wrong instrument

THE State Bank of Pakistan is trying to check inflation through just one instrument, the interest rate, based on the theological belief that the issue is demand, ignoring other, more critical factors fuelling inflation today. There are both demand pull and cost-push factors influencing inflation, and this instrument is being expected to achieve multiple objectives. The sources of demand in the economy are households, the corporate sector and government, who in turn receive money from different sources. The role of each source and what can be done about it is somewhat limited, especially because the acts of one can nullify the actions of others, at times as a result of unanticipated developments. For example, when the SBP increases the interest rate it expects a change in behaviour of the borrower. However, if the largest borrower, the government, whose imprudent and reckless fiscal behaviour has worsened the precariousness of our situation, simply continues borrowing to finance expenditures which (except on development projects) are politically inelastic in the short to medium term and are more than its revenues, it negates the objective of raising the interest rate.