Economic Decisions and Growth Trajectory

Posted by alice hall on March 27th, 2020

Economic decision making is crucial in steering the direction of and predicting the growth trajectory. At the micro-level, the financial/economic decisions are taken by a firm largely dictate its future growth and profitability. For instance, a decision by a firm to take on the debt burden to fuel its growth could prove to be its ticket to higher revenues and profitability in the short to medium term. Similarly, the decisions by the same firm to grow horizontally or vertically by taking control of its value chain can have a different impact on its future growth trajectory.

At the same micro-level, a firm’s product life cycle is also impacted. by the movements in the business/economic cycle. At the height of this cycle, the products which are even at the declining stage of their life cycle will show an uptick in their demand. An opposite case is true in the case of a product that is at the growth stage of its life cycle but met with a downward trend in the business/economic cycle.

At the macro level, the bouquet of economic decisions that could trigger economic growth is; Monetary policy, fiscal policy, and quantitative easing. These decisions in a real sense dictate the direction of the economy and nudge it in that direction

Monetary policy is the key measure that regulates the money supply via spurt or contraction of the money supply. Interest rates are its weapon. By lowering or increasing interest rates the Central bank controls s the money supply and consequently inflation.

Fiscal policy is another tool and a major economic decision that causes a growth trajectory. At the root of fiscal policy is the tax regimen, which is the main source of fiscal revenue. The government stimulates the economy through public spending, and thus brings the economy on the growth trajectory.

Quantitative easing is another path, that is taken to resurrect an economy and bring it back to a track that leads to growth. This tool was and some extent still is mainly in vogue throughout the Western world after the financial crises of 2008. As there was a serious economic meltdown after that crisis. The central banks in this scenario went on a bond-buying spree to lubricate the economic wheel, This was done through necessary cash injection.

Pakistan’s economy basically rests mainly on the pillar of monetary policy and to some extent on monetary easing and fiscal policy. But, monetary policy remains the mainstay that drives the economic cycle. As per SBP interest rates averaged 11.20 percent during the period 1992-2019. Currently, the rates stand at 13.25%. This figure depicts mainly the high level of inflation prevailing in the economy. So, interest rates had to be hiked and used as a sponge to suck this excess liquidity.

Open market operation (QE) is conducted by SBP to inject or mop up excess liquidity from the system. This is carried out by selling or purchasing government securities like T- bills mainly from banks. This is also a tool to control inflation. When there is excess money supply, the selling process of government securities takes place. This way inflationary pressure could be tackled. Similarly, the opposite is true, when there is a deflationary trend faced by the economy.,

On the fiscal policy front, the picture is also a bit dull. During the first half of the current financial year. The fiscal deficit crossed a 2% mark of GDP and was sitting at 2.3%. Although the government has tightened its belt and reduced its expenditure by 42% during this period. On the revenue side, the main source consists of taxes. As it can be seen that there is not much room in the economy due to its size and other inherent weaknesses to extract additional revenue. So, out of the box solution is required at this stage. What the government can do is broaden the tax net. This can be accomplished by lowering the tax rate. This is what Laffer’s principle states and the said model is also currently being applied successfully to the US economy.

The current catastrophe created by COVID-19 has compelled Central banks all over the world to use both relaxations in policy rates and QE to resurrect their economies. In the US the policy rates have gone to zero with a stimulus package of around 0bn announced by the Federal Reserve. In Pakistan also the rates have gone down by 0.75 percentage points. and have now been reduced to 11% and a package of Rs100bn announced by the SBP for the industry. The PM has also announced another package of around 1tn to boost the economy