A monetary policy too frequent

Monetary policymaking suffers from 'time inconsistency'; people expect the opposite of what policymakers announce.

Monetary policymaking suffers from what economists call ‘time inconsistency’. Simply put, it refers to the gap between what is announced and what is actually done. The result is that when policymakers announce that inflation will be brought down, people tend to believe the opposite. This is a crucial factor in determining the frequency of announcing monetary policy. The extent of time inconsistency depends on how good and recent the information available at the time of announcement is. Needless to say, this is also a key determinant of policy credibility.

The State Bank of Pakistan (SBP) announces its monetary stance or policy rate every two months. The last such announcement was made on September 29. It coincided with the end of the first quarter of the current financial year, 2010-11. What information was available in the “Monetary Policy Information Compendium” issued with the policy announcement? Virtually nothing in the real sector, as we do not yet produce quarterly estimates of GDP. Even the full year data related to the year 2009-10 consisted of provisional estimates. The only information available during the year relates to large-scale manufacturing sector and that too with a lag. Depending on the timing, it is also possible to make an assessment about the output of major crops. However, the Compendium contained the July-June (2009-10) information about large-scale manufacturing and crop targets for 2010-11. There is no problem in the monetary data collected by the SBP itself. It also has better access to selected financial data, though the financial soundness indicators related to April-July, 2010.

This state of information suggests that announcing the monetary policy every two months is a bit too frequent. Now, all kinds of frequencies are practiced around the globe — monthly, quarterly and semi-annual. But the frequency rises with the size and stage of the development of the economy. India, for instance, announces monetary policy every quarter. On the other end, the United States announces its stance eight times in a year and Japan twice a month. In our situation, which is not much different from India, quarterly announcement is the best we can hope for.

Of course in a crisis situation, a central bank does not have to wait for the pre-determined date of announcement. The SBP used to issue its monetary policy statement twice a year. In the midst of an economic and financial crisis, it deviated from its normal frequency and announced interim monetary policy measures in November 2008. This was followed by the decision to make quarterly announcements. The first quarterly monetary statement was announced for January-March 2009. In September 2009, however, the frequency was reduced to two months, with a one-line explanation that it would “help in addressing the uncertain and rapidly changing economic conditions.” Far from it. Apparently, it was an attempt by the then governor to create a feel-good factor for the increasingly restive business class by maintaining the rate at 13 per cent, followed by a negligible-but-government-inspired cut of 50 bases points (by half a per cent) in November 2009 and then maintaining it in January, March and May 2010. This do-nothing policy was pursued to please the government, appease the business class and confuse the public. The return to the policy rate of 13 per cent in July laid bare the gamesmanship involved in the two-monthly announcements. The sooner the SBP returns to a quarterly monetary policy announcement, the better. Given the frequency of the information available, this would lead to some reduction in uncertainty and allow people to form somewhat reasonable expectations.

Published in The Express Tribune, November 12^th, 2010.