Wednesday, 27 November 2013

Politics of inflation

The article is published in the Money Matters on 25 Nov 2013

Every political party emphasises the need to reduce inflation, create employment and alleviate poverty before elections. Inflation and unemployment are among the major concerns for policymakers as well with both variables of core importance while making macroeconomic policies.

Inflation is currently on the rise and it is expected that it will reach double digits in the current fiscal year against the target of 9.5 percent. The State Bank of Pakistan (SBP) has recently increased the discount rate by 50 basis points to reduce inflation. The PML-N government has been under attack since it came into power by other political parties as well as its critics due to the increase in inflation. The policies of the current government are being held responsible for higher than expected inflation. The agreement with the IMF is also severely criticised for playing a role in increasing inflation while some critics associate the programme with excessive borrowing by the government, buying foreign exchange from the market and depreciation in the exchange rate.

Economists, in general, associate inflation to the money supply in the long run, especially the excessive money supply. However, researchers have also tried to link inflation with the political economy, fiscal and structural variables. Without any doubt these variables have some effect on inflation in the short run but in the long run the sole determinant of inflation is money supply.

Contrary to these popular beliefs, an excessive increase in current inflation can be linked to four political factors which are strongly associated to the 2013 elections. However, in the end we’ll see that political factors are subjective and in reality it is the money supply which contributed to inflation only.

The federal government as well as the provincial governments increases their spending on the development projects before the elections to show their determination and commitment to development of Pakistan. The increase in development expenditures from 3.6 percent of GDP in 2011-12 to 4.4 percent of GDP in 2012-13 strengthens our claim that excessive money is spent on development projects before the election year. Thus money/funds which were hoarded are spent before the election to gain support of nation to vote for them.

Subsidies are among the most important variables which negatively affect inflation in the short run but in the long run they may affect the inflation rate positively depending on the financing process of subsidies. However, subsidies given to the farmers in the name of support price lead to an increase in inflation. Therefore, the nature of subsidies is also important. It can be in the form of cash transfers such as income support programmes, support price to specific a sector, interest free loans or loans provided at a lower rate than the market prevailing interest rate such as an export finance scheme, tax holidays and rebates to different sectors such as duty drawback to the export sector. Before the elections subsidies are also used to control the prices if they are expected to go up. The best example in our context would be subsidies given to the energy sector. Circular debt was the outcome of several subsidies given by the government not to increase the price of electricity.

An excessive increase in the money supply to mitigate the gap between potential and actual employment is a major socio-political economic policy. This policy leads to trade-off between inflation and employment since increase in money supply may increase employment in the short run but eventually contributes to inflation. However, excessive monetary borrowing was carried out to finance the budget deficit before the elections and continuous purchase of domestic assets to increase foreign exchange injections into the market to control the exchange rate may not give us a clear illustration of our claim. 

Moreover, money spent on election campaigns including public meetings, poster printing etc increases domestic commerce activity. Politicians and political parties spend billions of rupees on their election campaigns every five years. The money hoarded by either politicians, political parties or their financers is given to the people who are involved in their election campaigns.

Furthermore, black money is also involved in elections, which is either used to gain the support of leaders in the villages or given to their workers, mostly belonging to lower middle class who will do various chores for them related to election campaigns. Nevertheless, money circulation will increase in the economy which increases the purchasing power of the people to spend on various items, particularly food. Therefore, expectations of an increase in the purchasing power lead to increase in food prices. This is also evident in the first three months of the current fiscal year with food inflation more than non-food inflation, opposite to the trend in 2011-12.

The above discussion on a possible increase in inflation is based on politics. However, each case presented in this article is related to circulation of money in the economy which leads to inflation. Research tells us that the impact of money supply affects inflation with a nine to ten month lag. The effect of money supply on inflation may take more time if it is hoarded by people or institutions for a longer period. Therefore, we can conclude that current rise in inflation is the lag effect of previous year’s policies of the last government which are strongly associated with the 2013 elections and the money spent on elections by politicians and political parties. Moreover, as economists suggests it is the money supply which is the sole determinant of inflation.
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Wednesday, 13 November 2013

Difference between mutually exclusive event and independent event

While teaching course of Statistics at PIDE I realized that students are in general confused between mutually exclusive events and independent events. Since I taught this concept recently thus i thought that i should upload the explanation. There are good chances that some other websites have explained this as well.

Mutually Exclusive events are those events which cannot occur together/simultaneously. Moreover in simpler words if certain events cannot happen together at the same time then those events are known as mutually exclusive events.
For Example: (1) Its raining outside and it's not raining outside (2) he had tea in office and he did not have tea in office (3) arrow hitting a dart and not hitting a dart (4) cyclone happen and not happen (5) sick and not sick. All the examples are very clear that  these events can occur at the same time.
Independent Events are those event which can occur together but there is no association between them. For instance (1) it will rain today as well as we will have too much work in office (2)Teacher will take a class and painter paint a portrait (3) purchase a computer and eating eggs in breakfast (4) elections in India and tree plantation in England. All the examples show that the events can occur at the same time but there is not correlation between the two variables.

Monday, 4 November 2013

Addressing Electricity Shortage through Electricity Conservation

Published in Money Matters, November 4, 2013 entitled "Energy: Tackling the Crisis"
Pakistan has been facing a severe energy crisis since 2007, which has badly affected its industrial sector. The main reason for the crisis is that in the past, efforts were not taken to enhance the power generation capacity by installing new plants or building new dams.

The CNG policy has proved to be another nail in the coffin. But the new government has been contemplating to abolish its supply to vehicles, especially in the coming winter in order to provide continuous supply to households as well as to the industrial sector.

Addressing energy shortages has been one of the main priorities of the PML-N government. In fact, Prime Minister Nawaz Sharif’s first public speech (right after winning the elections) focused on addressing electricity shortages. And his political party started working on mitigating the crisis in the quickest time possible by signing international and national contracts for electricity generation as well as paying off a part of circular debt.

According to studies conducted by Pakistan Institute of Development Economics (PIDE), governance, capacity issues and circular debt are the major factors behind the crisis. The crisis can be mitigated by resolving any one of these three issues and can be completely abolished by simultaneously addressing all the three issues.

Apart from that, a USAID and Planning Commission’s Framework for Economic Growth (FEG) report emphasised on governance issues to eradicate the issue of circular debt as well as making circular debt part of debt financing.

The severity of the energy crisis has been increasing since 2007. Undoubtedly, the new government is adamant to eradicate the crisis but it would take three to four years to overcome energy shortfall. Governance, as stated in the Planning Commission’s FEG report, is among the quickest ways to lessen the crisis. Another equally important step, which has been deliberated for weeks by Federal Minister for Water and Power Khawaja Asif, is of energy conservation.

Several energy conservation strategies have been implemented in the country, such as use of energy savers, implementation of daylight saving time (DST) plan and early closure of markets. However, these strategies have failed to achieve the desired result. Let’s take a look at the three strategies:

Daylight saving time (DST) helps conserve electricity by reducing the gap of excess demand, especially in summers. This enables individuals to use an extra hour of daylight in evenings by making use of less artificial lights.

Daylight saving time has been implemented thrice in the country since its inception. As energy demand increased in summer, daylight saving time was implemented for the first time in 2002 from April-October. Thereafter, it was executed again in 2008 from June to October and April to October in 2009.

The daylight saving plan has mostly failed in the country due to non-acceptability. Generally, people used to change their work hours with the plan, which subsided the impact of advancing clocks by an hour. At the commercial level, a minimum of one hour of electricity was saved by the end of the day.

By spreading awareness and executing proper research, the government can implement the daylight saving plan more effectively.

The use of energy savers helps save electricity but it doesn’t reduce consumption. Hence, it is an energy efficiency strategy. Despite the fact that the use of energy efficient appliances have been on the rise since the last one decade, it is difficult to ascertain if the overall consumption has decreased.

Early closure of markets is a vital policy that can save electricity. But either the authorities are fearful of retailers/wholesalers or there is a lack of will as it has not been implemented effectively. In Europe, more than 95 percent of markets shut down by 6 pm or 8 pm and if the same policy is implemented in Pakistan, customers will adjust to timings and thereby save significant amounts of electricity.   

Although not a popular measure, increasing electricity prices will compel the consumers to reduce its usage. We recently experienced the reaction of the people, political parties and even the Supreme Court when the government announced rise in electricity prices. Rationalisation of electricity prices is important – be it producer or consumer price rationing.

Similarly, there are certain measures that can be taken at the individual level to conserve energy. These include: building energy-efficient buildings, less use of high electricity consuming appliances and creating awareness campaigns.

The abovementioned conservation strategies can be easily implemented without increasing government’s expenses. Thus, the government needs to pursue different conservation policies by coordinating with households and industrialists.

Most importantly, implementation is the key to get the desired results. Remember, a megawatt saved is better than a megawatt produced

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