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Wednesday, July 17, 2024

Rising inflation and the role of IMF

Inflation occurs when the money supply of a country grows more rapidly than the economic output of a country. 

The International Monetary Fund (IMF) approved the largest-ever distribution of monetary reserves of $650 billion to boost the global economy and help emerging and low-income nations deal with the mounting debt and Covid-19 crises in the year 2021. Moreover, IMF is considering to allow all member countries to borrow up to an additional 50 percent of their IMF quota under the RFI (Rapid Financing Instrument).

The Rapid Financing Instrument(RFI) and the corresponding Rapid Credit Facility (RCF) for low-income countries provide rapid assistance to countries with urgent balance of payments need, including from commodity price shocks, natural disasters, and domestic fragilities.

Read more: SBP receives loan tranche of $1.16bn amid dwindling forex reserves

On the other hand, Managing Director of IMF news Kristalina Georgieva said, “inflation is stubborn and more broad-based than we thought it would be.”

Inflation occurs when the money supply of a country grows more rapidly than the economic output of a country.

Broadly speaking, there are three main types of inflation which include demand-pull inflation, cost-push inflation and monetary inflation.

Demand-pull inflation occurs when aggregate demand in the economy outstrips aggregate supply. In this process, too many buyers chase too few goods. This leads to a rise in prices.

Cost-push inflation occurs when the cost of business increases in the form of higher energy prices, higher raw material prices and rising wages.

Due to the rising costs, the aggregate supply retreats and again many buyers end up chasing fewer goods. This again leads to a rise in prices.

Read more: Weekly inflation touches the sky, hitting a 14 year high

The third and most difficult form of inflation occurs when money supply increases in the economy at a rate much higher than the gross domestic product (GDP).

This is irreversible inflation and is the most difficult to handle. It reduces the value of currency. Too many currency notes end up chasing too few goods.

In an IMF working paper – “Central Bank Credit to the Government: What Can We Learn from International Practices?” – this issue is discussed in detail.

It is a key finding of this paper that government borrowing from the central bank, which increases money supply, is the most chronic source of inflation.

This not only puts upward pressure on inflation, but also leads to exchange rate depreciation, giving birth to an inflationary spiral that keeps on feeding itself.

In the case of Pakistan, for almost last 9-10 years, the money supply (broad money – M2) has exhibited a compound annual growth rate (CAGR) of 14 percent whereas GDP at current prices increased only 9 percent.

This means that too much money is chasing too few goods, and this is the main and most chronic cause of inflation.

Pakistan is facing a number of economic challenges including rising inflation. Poor as well as middle class of the society is struggling to meet the ends. Inflation control is one of the two main economic priorities of the government along with maintaining balance of payments equilibrium.

Moreover, catastrophic floods gave another jolt to the already weakened economy. According to the World Economic Outlook July 2022, global GDP is expected to grow by 3.2 percent in 2022 from 6.1 percent in 2021.