Monetary and Fiscal Policies Coordination: Pakistan’s Experience Muhammad Farooq Arby* Muhammad Nadeem Hanif *
The paper explores how the monetary and fiscal policies have coordinated with each other in Pakistan. It argues that monetary and fiscal policies have been executed independently throughout the study period that is 1964-65 to 2008-09 and there have been very few instances of coordination between the two policies while addressing prevailing economic conditions. The paper does not find any difference between the behavior of monetary and fiscal policies before and after the establishment of Monetary and Fiscal Policies Coordination Board in 1994. Whatever instances of coordination were found were clustered in military regimes; which may be one of the reasons of macroeconomic stability in such regimes.
JEL Classification: E61, H30 Keywords: monetary policy, fiscal policy
1. Introduction Different macroeconomic policies are formulated and implemented through different institutional arrangements, though broad objective of the policies is usually the same, i.e., increasing the material welfare of the people of the country. The most dominant policy objectives are achieving high employment and low inflation. There are two major groups of policy instruments to achieve these objectives; one is related to monetary conditions, that is used by central banks with the primary objective of maintaining price stability; and the other to fiscal conditions, that is employed by the ministry of finance to improve overall economic performance. However, the objectives of fiscal policies are usually inclined towards high growth and employment even at cost of high inflation. With this dichotomy in policy objectives of monetary and fiscal authorities, there is a risk of quashing each other’s actions. It warrants some sort of monetary and fiscal policies coordination with arrangement for exchange of information in timely *: The authors are senior economists at the State Bank of Pakistan; email@example.com
SBP Research Bulletin, Vol. 6, No. 1, May, 2010
manner and setting mutually agreed targets for key economic indicators. Agreement about the targets of output and inflation creates a monetary-fiscal symbiosis, yielding the ideal outcome despite disagreement about relative weights of the two objectives (Dixit and Lambertini, 2001). The coordination in this context does not put the central bank’s autonomy into the shade. Instead it is to ensure effectiveness of both the policies. A non-coordinating behavior of any one party not only renders policies ineffective but also adversely affects the credibility of both the fiscal and monetary authorities. The experience of recent global financial and economic crisis fortifies the need for coordination among macroeconomic policies to effectively address the shocks. A coordinated policy response to economic shocks increases the speed of convergence to the steady state and leads the economy closer to the planned target as compared to the outcome of the non-cooperative policy moves as noted by Tabellini (1986). Dahan (1998) also stresses on the need for the monetary and fiscal policies coordination after studying budgetary implications of central bank’s actions and monetary implications of government’s reactions. The need for policy coordination also arises in the case of structural reforms and liberalization of the financial sector. Such reforms can only succeed within the framework of a supportive fiscal policy that provides macroeconomic stability, fiscal discipline, and avoidance of taxes that discriminate against financial activity. Together with improved legal, accounting and regulatory systems in the financial sector, these are the prerequisites for successful financial liberalization (World Bank, 1989). If high fiscal deficits persist while the authorities are undertaking the reforms of the financial sector, interest rates...