Since the decision didn't come, something to bore the night owls into sleep.

I had planned to do this thread later but Raza lovers group made an appearance though Volker Taya and Samuelson Dada group were silent. How a high discount rate is expected to reduce inflation?

Abu groups answer will be:

When interest rates rise, people who have taken personal loans, variable interest rate mortgages etc (I know I know, bear with me), the interest expense on their loans go up. More of their disposable income now goes to pay interest.

This leaves them with less income to spend on other goods. This results in a decrease in demand for those goods resulting in decrease in the price of those goods. Thus, inflation is brought down. This is one-half of their argument.

A person on street “but..but.. we don’t borrow from banks so how will this reduce demand or bring down inflation?” What do the people on the street know as they aren’t experts on how many different ways there are to measure inflation or read business press or have econ degrees

The other half of the argument concerns the business side. Businesses (not all) borrow. An increase in the discount rate will affect their profit if discount rate affects KIBOR. In 2005, when the discount rate was also high, KIBOR wasn’t. But now KIBOR is following discount rate

Higher KIBOR means that businesses that borrow will make lower profits. Car companies don’t borrow as they are cash rich from all the booking money in advance. But your textile exporters, cement manufacturers, steel, fertilizer plants etc borrow.

Exporters may be immune as they get subsidized interest in form of SBP refinance yet they still cry on refunds. Other industries aren’t lucky. They may try to increase prices to maintain profit or reduce/shutdown operations as working capital is incurring high interest.

If they reduce operations, they may fire staff, but this will also reduce demand for inputs such as electricity, raw material, fuel etc. Now it depends on what is the raw material.

If it’s Mitchell that’s buying tomatoes for its ketchup, it will buy less tomatoes if slowing down production. Hence, tomato prices may decrease. But if it is an industry that uses imported medicinal, chemicals, coal, petrol etc, decrease in demand will not affect their price.

People on the street may ask you “how is firing people and shutting down industries going to help in reducing prices?” You can reply that now unemployed will not create unnecessary demand for goods. This will reduce prices.

They may retort, “We already have so many underemployed and unemployed in this country. Do you really think these few low-income earners were causing inflation?"

You : “Do you even know how CPI is measured? Have you studied economics? It is an established fact not only in textbooks but all reknowned economists swear by it that when inflation is high, you increase interest rates. Capice”. This will shut those nosy people.

Let’s take a hypothetical example. No. Not tomatoes. My passion ie Housing. Let us say there is a sudden influx of refugees. There will be a shortage of housing units. Rents will go up.

Your sabzi walla who may not even have a bank account much less a mortgage may increase the price of tomatoes (sorry, couldn’t help it) as he now has to earn more income to pay higher rent, a second-order effect ie rent increase resulted in an increase in prices of other goods.

The CPI/inflation will go up. What will the govt do? It CAN encourage the construction industry through reduced rates and other incentives to build more housing. But if govt has expertise in macroeconomics, it will increase interest rates as Samuelson Dada said.

Developers, if they borrow, will cancel projects as they won’t be making any profits after paying interest. Man on the street will say, “This may just bring down inflation. After all you are the expert."

Enough with hypotheticals.

Back in our world, the man on the street will now ask “you said slowing factories will use less electricity. This will reduce electricity demand. You taught me a reduction in demand leads to a drop in price. Will my electricity bill go down?” O the naivete of the common man.

He doesn’t know that utilities have fixed costs (capacity charges) that are divided over all payers. Once factories shut down, these charges will be borne by existing bill payers. Thus, his utility bills actually go up.

Moreover, the circular debt that is incurred by the government will now attract higher interest charges due to an increase in interest rates. Either this higher interest cost will be shifted to consumers in bills or the government will decide to reduce the services it provides.

The naïve persons who have wisened up will not ask about the services the government is providing. But a double whammy for them ie not only paying higher per-unit charges but eventually will also be paying for the higher discount rates applied on circular debt.

But now that higher electricity prices will leave little for him to pay for food, rent and kid’s school fees, he will cut back on some of the stuff he is buying. This will bring down demand for goods and thus their prices and hence inflation will come down. QED.

Some times it takes one a while to understand the perspicacity of the advisors to the government.

My point is SBP has the data as it collects information on borrowers from banks, understands linkages of industries, their inputs, what and how much is imported. If a segment is causing inflation, tools are available now to target that sector/industry. Let’s not use the hammer.

So who does this benefit? I don’t know. The government is targeting equivalent to $5Billion in T-bills. That means $50+ million of monthly interest payment at 13% for a government that incessantly complains about interest on debt that was taken to build infrastructure.

If the investor was local, he would have invested the interest locally and this may have started the economy. Now all the interest will go abroad and add to their economies and bottom lines.

There is more but I think this is enough. Good night.