Resource generation for a sovereign country

By Dr Atiq-ur-Rehman

COVID-19 was not only a pandemic; it also brought an economic crisis in the entire world.
Many economies saw worst recession of the recent history.

GDP of some countries fell by more than 10% in the first half of 2020 and above 150 of the UN member states recorded a fall in GDP.

In such a situation, no country can expect an extraordinary improvement in government revenue and/or a financial support from other countries.

Despite all this, many countries provided huge packages for their citizens to come out of the financial crunch.

For example, Canada, having total revenue of about CA$ 330 billion in 2019, provided a fiscal stimulus of over CA$350 billion in Covid-19 relief packages.

This is despite the fact that Canada had been running a deficit budget continuously since 2016.

Similarly, the total budget of Italy for the year 2019 had been about €850 billion and in 2020, Italy provided €500 billion as fiscal stimulus and €700 billion as loan guarantees.

Germany, New Zealand, the US and UK are among the nations consuming over-generously on the Covid relief.

How is it possible to manage such huge relief packages, surpassing their entire revenue collection, especially for the governments running deficits for last many years?
The sovereign governments have the right to create money using their central banks, as and when needed.

The governments used their central banks to create money to provide the packages. That’s the answer to the mystery.

But the question arises; why do sovereign governments collect taxes when they have authority to create money at almost no cost? The creation of money needs some very careful considerations.

An expansion in money supply without expansion in the economic activity would simply increase the nominal prices.

For example, suppose an economy is producing 10 Kg of butter, and has $100 of money supply, the price of each kg of butter would be $10.

If money supply is made $400 without increased production, each kg of butter would sell at $40.

But suppose the new money is used to produce new supply of butter, then the monetary expansion needs not to be inflationary.

Some of the countries have experienced hyperinflation in the recent past due to faster expansion in money supply.

For example, in 2006, the central bank of Zimbabwe announced to print money to retire some of its debt, and in subsequent years inflation went out of control.

In 2007, the inflation exceeded 1000,000% per year and finally Zimbabwe had to abandon its currency in 2009.

However, if monetary expansion is used to boost economic activity, it is not necessarily inflationary. In fact, monetary expansion is the tool to bring the economy out of financial crunch.

John Maynard Keynes is considered as the most influential economist of the 20th century.

For the economic recovery, Keynes prescribed, ‘Government should spend money to dig holes in the ground and then to fill them up’.

Keynes prescription actually means that at the time of crisis, governments should consume on projects even without any economic feasibility.

When we are talking about economic recession, this means revenues have fallen and the governments can sponsor such projects only by monetary expansion.

Monetary expansion was used to overcome the Global Financial Crisis of 2007-8, and it is the most popular tool used by the governments to deal with the financial effects of recent pandemic.

The resources, both physical and human, are lying unutilized in Pakistan. We have millions of acres of land which needs to be upgraded to be productive, millions acre feet of water flowing to the ocean and millions of unemployed youth.

If the money supply is expanded for the purpose of financing a dam, or for up-gradation of marginal land, it would be an entire new economic activity and the expansion would only expand the market creating new jobs for the youth.

There are many examples of huge monetary injections without any inflationary impact, with some examples mentioned above.

The United Kingdom announced to support 80% of the income of self-employed and furloughed workers and reduced the policy rate from 0.7% to 0.1%during the recent pandemic.

The inflation in the UK before the pandemic was 1.79% which declined to 0.77% despite the huge injection.

The containment measures taken by Pakistan have only added to the financial distress.

When the PTI Government took charge in 2018, the government borrowing from SBP was about 5.3 trillion.

The Government banned further borrowing from SBP and borrowed from commercial banks to retire entire debt of SBP.

The purpose of this exercise was to contain the inflation, but inflation during entire period of current regime has been higher than that of previous government.

If government borrows from SBP, the mark-up this debt comes back to government treasury; therefore, practically this is a kind of interest free loan.

By borrowing from commercial banks, the mark-up on such loans will now go to commercial banks.

Therefore, replacement of SBP loans with the loans from commercial banks on one hand reduced availability of loanable funds for private businesses, on the other hand, increased burden on national exchequer in the form of mark-up payments to commercial banks At this time, the government needs an expansionary fiscal and monetary policy, and spend on the development projects such as dams and roads, so that the employment opportunities for the youth could be generated.

The resources in the form of natural resource endowment and the human resources are already present, what is needed at this time is to use the monetary sovereignty effectively and wisely.

—The writer is Associate Professor, Director, Kashmir Institute of Economics, Chairman, Department of Islamic Economy and Banking Managing Editor, Kashmir Economic Review University of Azad Jammu and Kashmir.

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