Dear MPC Members

Assalamo Alaikum and Guzishta Eid Mubarak.

I was recently re-appointed to the MPC committee after the expiry of my three-year term in January 2019. I attended my first meeting about five years ago, when MPC was just an advisory committee to FM and Gov SBP. Some time after that, the government approved the charter for the current form of the MPC, which now actually makes the final decisions. I was shocked and horrified at the first meeting at the casual and non-serious attitude with which this decision at the heart of economy was being made. One of the members actually said that the market was betting that we would lower the rate, so we should increase it instead, to surprise them. I said this was not a game we were playing, but our decision would impact heavily on jobs and inflation, on the lives of millions. I circulated a brief note entitled “Shooting in the Dark” (attached), which described the completely ad-hoc nature of MPC decision making at that time. There was a strong positive response from SBP to this note, and since then the decision making process has substantially improved. Currently, we see large amounts of organized data, model based analysis and other relevant considerations being discussed and debated at the MPC Decision. I believe that our decision making processes at the SBP are now on par with global best practices in this area.

However, we cannot afford to relax. These are critical times, and a large number of dynamic changes are taking place in the global economy. Central Banking has evolved and changed in response to these, and the inadequacy of current methods was clearly demonstrated by the Global Financial Crisis and the global recession which followed. There is increasing debate, and many recommendations about how we can improve Central Banking to prevent future recessions, and provide improved support for both domestic and global economy. This is especially important because the optimal requirements for one goal often conflict with those of the other.

Over the period that I have been associated with the MPC, I have made a deep study of Central Banking, in order to be able to make informed decisions. In this email, I would to share some of the insights I have acquired, which are not part of conventional macro courses, and therefore not easily accessible to either academicians or practitioners. I would appreciate it very much if the MPC members could study these materials, so that we could also be on the same page in terms of how to think about the decision. I would also like to propose some serious changes in the terms of reference of the MPC, to extend the decision beyond just the overnight discount rate, on the basis of the theoretical understanding which has emerged in the post GFC era. But I will defer this topic until later.

Here are some key readings about Central Banking which are not easily accessible:

Summary of Stiglitz on Monetary Policy: Stiglitz draws lessons on how we should conduct monetary policy in light of lessons learned from the Global Financial Crisis: https://weapedagogy.wordpress.com/2018/08/31/summary-of-stiglitz-on-monetary-policy/

The Class Conflict Theory of Inflation: Post starts by discussing Daniel Tarullo, Governor Fed, paper on how economist do not have a working theory of inflation. It goes on to provide a Post-Keynesian theory, which is driven by radically different mechanisms from those which we learn in standard economic theory, which reduces inflation to a monetary phenomenon. Naturally, correctly understanding the mechanisms of inflation would have a dramatic impact on monetary policy. https://weapedagogy.wordpress.com/2018/12/27/class-conflict-theory-of-inflation/

Understanding how Central Banking has evolved with changing economic circumstances is of great value in understanding how we can improve current methods at the MPC. Those who do not understand past mistakes are doomed to repeat them. In this connection, the place to start is with the history of the Bank of England, the mother of all Central Banks:

The Origins of Central Banking: This post provides the historical context in which the Bank of England was created, which is of great value in understanding how Central Banks function, even today. https://weapedagogy.wordpress.com/2019/03/31/origins-of-central-banking/

Monetization, Maturity Transformation, and MMT: This post analyzes the history of creation of the Bank of England from a theoretical perspective, and draws out the technical lessons which we can learn from this history. It also connects this history to Modern Monetary Theory (MMT). https://weapedagogy.wordpress.com/2019/05/29/monetization-maturity-tranformation-and-mmt/

Finally, because of my interest in Islamic Economics and Islamic Banking, I have been looking into the Gold Standard. Many people think that this is the Islamic method of money creation. I have come to the conclusion that the Gold standard is a hopelessly bad way of running the global economy. It functioned only for about a century leading up to the first World War. Karl Polanyi says that it was the futile attempts to restore the Gold Standard which eventually led to WW2 (for a synopsis, see my “Summary of the Great Transformation” and “The Hundred Year Peace”). The history of the rise and fall of the Gold Standard is summarized in two lectures listed below. These are not directly relevant, but very important as pre-history, because they provide the reasons why the modern monetary system takes the shape that it currently does.

On the Vital Importance of Understanding the Global Financial Architecture: This post explains the virtues and defects of the gold standard, and how WW1 depleted European treasuries, leading to a collapse of the Gold Standard. How all efforts to restore the Standard failed, and so Bretton-Woods conference created an alternative, known as the gold-exchange standard.

Global Financial Architecture Part II: This continues the historical analysis following the Bretton Woods Conference, to the Nixon Shock of 1971, which officially ended the Gold Standard and led to the current world of fiat currencies and floating exchange rates. The central idea of MMT is that our theories are based on Gold Standard, while the world has moved on and our theories have not kept up to modern realities of money. https://azprojects.wordpress.com/2018/06/29/international-financial-architecture-part-ii/

As a consequence of the collapse of Bretton Woods agreement, A Lopsided Monetary System emerged. The current global trading system is heavily biased towards dollars, giving USA the power to create gold by printing it, while other countries must export real goods to earn dollars that they need for trade. https://azprojects.wordpress.com/2018/12/16/the-need-for-unity/.

Finally, Modern Monetary Theory is based on the realization that a world of fiat currencies and floating exchange rates is radically different from a world of gold based currencies. Ancient Monetary theory was developed in the world of the gold standard, and has not been updated to keep up with modern developments. Once we understand that sovereign currencies come into existence by the authority of the state, the role of taxation, deficits, fiscal and monetary policies changes in ways that are outside the scope of what is taught in current textbooks of macroeconomics. https://weapedagogy.wordpress.com/2018/11/02/modern-monetary-theory/

This is a heavy collection of readings, but the MPC is also a heavy responsibility. These readings represent some of the key insights that I have acquired over five years of study, and so provide a digestible summary of a huge amount of literature. We also have some time before the next MPC meeting. Looking forward to meeting all of you at the next meeting.