Download 1. Findings of Exploratory Analysis FY58-FY07

An Exploratory Analysis of Inflation Episodes in Pakistan
by
Riaz Riazuddin
Economic Adviser
State Bank of Pakistan
The Fourth Annual Conference on
Management of the Pakistan Economy
Lahore School of Economics
24-25 April, 2008
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Roadmap
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7.
Findings of Exploratory Analysis FY58-FY07
Approach followed
Interactions between Money and Inflation
Interactions between Money and Food Inflation
Interactions between Inflation and Real GDP Growth
Policy Implications
What happens when policy prescriptions are not
followed (Examples from “The History of Inflation in
Turkey”)
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1. Findings of Exploratory Analysis FY58-FY07
• Old wine in old bottle
– Inflation is primarily a monetary phenomena
• Quantity theory of money works in Pakistan at money
growths of at least 9% per annum.
• Quantity theory of money does not seem to work at
money growth rates of less than 9%.
• Food inflation is also a monetary phenomena
• Inflation is independent of growth.
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2. Approach Followed
• Old wine in new bottle
• Use of sturdy application of statistics in biomedical science to dismal science of economics
• Does an allopathic medicine really work to
remove a sickness?
• In order to answer above question, explore a
four-fold table (contingency table) and apply an
appropriate statistical test
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2. Approach Followed (cont’d)
Placebo
Sick
No. of Cases
Healthy
18
6
Total
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(Don’t do anything)
Real Medicine
(0.75)
7
19
26
(Apply scientific
treatment)
Total
(0.25)
(0.269)
25
(0.731)
25
(0.5)
(0.5)
50
In order to prove that real medicine is significantly superior to placebo,
pharmacists have to reject the following hypothesis:
Ho : Probability of sickness when placebo is given is higher than
Probability of sickness when real medicine is applied.
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2. Approach Followed (cont’d)
In above table, pharmacists have to show that 0.750 is
greater than 0.269, not as a result of coincidence, but due to
use of scientific medicine.
Statisticians use either Chi-square test (when cell values are
(large), or Fisher’s Exact Test (when cell values are very low)
before deciding the case in favour or against a medicine.
In above example superiority of placebo (over real medicine)
gets rejected for removing a sickness. This means that real
medicine is effective in curing the sickness.
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3. Interactions between Money and Inflation
Inflation next year
Broad
money
growth
2X2 Table
High (> 7%)
Low (≤ 7%)
No. of Years
High (>
14%)
18
6
24
Low (≤ 14%)
7
19
26
No. of Years
25
25
50
Above table is exactly what I show in page 2 of my paper.
Result of Test:
Reject: High money growth is effective in containing inflation to low levels.
Accept: Low money growth is effective in containing inflation to low level.
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3. Interactions between Money and Inflation (cont’d)
Since our lables are arbitrary, as opposed to precise
definitions of ‘Sickness’, ‘Healthy’, ‘Placebo’ and ‘Real
Medicine’ in medical sciences, therefore we need to be
careful and find a way to remove arbitrariness from our
approach. So let us do this for all possible (if not all, for a
large number of) interactions of money growth (high-low)
and inflation (high-low) next year. 105 interactions have
been ‘chosen’ by taking M2 growth cut-offs (4,5,6,……,
18; i.e 15 values) and inflation cut-offs (4,5,6,……,10; i.e
7 values); this gives 15x7 = 105 interactions.
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3. Interactions between Money and Inflation (cont’d)
1.0
0.9
0.8
0.7
0.6
<=7
<=6
0.5
<=5
0.4
0.3
<=4
0.2
0.1
<=18
<=17
<=16
<=15
<=14
<=13
<=12
<=11
<=10
<=9
<=8
<=7
<=6
<=5
0.0
<=4
Table 5 of my paper shows that
medicine of low money growth works
very effectively at money growth
rates of higher than 9% and lower
than 12%. Placebo i.e., high money
growth was found to work as
effectively as the real medicine when
money growth rates are lower than
9%! Simple monetary rule of keeping
money growth lower than 12% is
derived by inspection of 105x4 = 420
probabilities shown in Figure 3 and
Table 4 of my paper
M2 growth (%)
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4. Interactions between Money and Food
Inflation FY58-FY07
Same approach also found money growth to be
associated with food inflation of next year.
Simple monetary rule for keeping food inflation
at low levels is to keep money growths further
lower by one percentage point, required for
keeping inflation at low levels. Tests were not
carried out because of the obvious similarity of
results with earlier interactions, but these can be
performed very easily.
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5. Interactions between Real GDP Growth
and Inflation FY58-FY07
Same exploration gave 9x7 = 63 interactions of
Real GDP Growth (1,2, …., 9%; 9 cut-off values)
and inflation (4,5, ……., 10%; 7 cut-off values).
Result is very surprising, but in full conformity with
common sense, as well as economic theory. The
result is that inflation and real GDP growth are
independent factors.
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6. Policy Implication
Hence, inflation should be attacked by
policies fully independently from
government’s policies of pursuing
economic growth.
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7. What happens when monetary policy is not independent of
growth policies?
(Examples from “The History of Inflation in Turkey”)
The reflection of a salary earner on various days of the month…
Eat and drink, don’t
worry…
You can save by eating
less!
Two glasses of water are
worth one slice of bread!
Cemal Nadir Caricature Album, Aksam Publishing house 1933, p. 51.
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7. What happens when monetary policy is not independent of
growth policies?
Inflation hits everyone…
Inflation:
18.9%
22.5%
6 2.0%
101.4% (1980)
Cumhuriyet, 18.02.1980
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Thanks
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