Pakistan’s recent inflationary episode is mainly driven by higher fuel prices, freight shipping costs, and insurance charges, caused by oil price (supply) shocks resulting from the closure of the Strait of Hormuz due to the Iran–US war. The higher fuel costs may have a devastating impact on Pakistan's economy, as oil is the single most important energy source that drives the wheels of the economy. These inflationary pressures have progressed rapidly, as transportation and logistics costs, food and non-food prices, and the costs of raw materials for farming, industry, and trade have increased drastically in just a half-month period.

Further, if these inflationary pressures are prolonged and become permanent, the economy will experience the second-round effect in terms of wage and price-setting behaviours. In this trajectory, controlling the rising inflation is the foremost policy concern for most central banks, and foreseeing this, the State Bank of Pakistan has increased the policy rate by 100 basis points in its April Monetary Policy Committee meeting.

But the question arises here: “Is the recent State Bank of Pakistan action, i.e., monetary tightening stance, the right response to energy price-driven inflation in Pakistan”, when the economy is in its early recovery stage after a long period of economic recession. Empirical evidence suggests that tightening monetary policy will have a deeper recessionary impact on the economy in terms of significant welfare losses for households, businesses, and credit markets. In this op-ed, the author discusses the State Bank of Pakistan's recent rise in the policy........

© The Friday Times