RECORDER REPORT

KARACHI: GDP growth has closed link with inflation and if inflation goes beyond 6 percent it adversely affects the growth.

According to State Bank of Pakistan (SBP) Working Paper Series “Threshold inflation in Pakistan”, written by Muhammad Farooq Arby and Amjad Ali, inflation below 5.67 percent may be favourable for economic growth and inflation above 6.05 percent can hurt growth.

The study estimates the relationship between inflation and growth in Pakistan with especially focusing on the existence of threshold effect of inflation. It is generally believed that inflation has a non linear relationship with growth, i.e., it affects growth positively when it is low and stable, and negatively when it is high.

However, in case of Pakistan, the authors have find a number of years when high inflation and high growth co-existed and similarly low inflation was observed in the periods of low growth. Therefore, it becomes a difficult task to find threshold inflation in Pakistan with the given data set.

“We have used two different methodologies on annual data and found very close results i.e. 6.05 and 5.67 percent. First we estimate a quadratic equation for growth over annual data from 1976 to 2017 and find that the growth is maximized at 6.05 percent inflation. Second we estimate a regression kinked model by using Hansen (2015) technique which gives threshold inflation of 5.67 percent”, the authors said.

Keeping in view these close threshold inflation levels, they concluded that inflation below 5.67 percent may be favourable for economic growth and inflation above 6.05 percent can hurt growth.

Historically, average real GDP growth rate has been more than 5 percent during the low inflation periods (i.e., below 6 percent), and 4.7 percent during very high inflation periods (i.e., above 6 percent).

There was only one year (FY1990) when inflation was exactly at 6 percent and average real GDP growth was recorded 4.6 percent – lower than its historical average. Therefore, a more careful policy is required when inflation crosses the threshold level, they mentioned.