What is Driving Pakistan’s Inflation: Money or Wheat?

International Monetary Fund. External Relations Dept.
Published Date:
June 2006
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Inflation in Pakistan rose rapidly in 2004 and remained high through 2005. Fingers of blame are pointing in two different directions: an increase in the wheat support price and monetary growth. A recent IMF Working Paper examines the contributions that both have made and finds strong evidence that the influence of monetary policy is decisive.

Following a financial crisis in 1998–99, Pakistan’s inflation dropped to less than 5 percent a year and remained at that level through 2003. Tight monetary policy, combined with fiscal consolidation, contributed to this low-inflation environment (see top chart). Starting in 2002, however, monetary growth picked up, and inflation, with a one-year lag, increased sharply in late 2003 and 2004. This acceleration also coincided with two increases in the country’s wheat support price—the guaranteed minimum price that the government pays for wheat (see bottom chart).

What was to blame for the rise in inflation? Do supply constraints (or administered prices) drive up the prices of specific goods and, through second-round effects, affect the overall price level and inflation? To take a closer look at what was driving Pakistan’s inflation, the study examined the role played by monetary growth (measured by broad money or credit to the private sector), real GDP growth, the interest rate, exchange rate movements, and increases in the wheat support price.

The results suggest that monetary factors are the main drivers of inflation in Pakistan. Monetary factors, particularly private sector credit, affect inflation with a lag of about one year. In addition, increases in the wheat support price influence inflation in the short run. Thus, over the medium term, the wheat support price can affect inflation only if accommodated by monetary policy.

Price of wheat

Recent support price increase coincided with an uptick in inflation.

Data: Pakistani authorities and IMF staff calculations.

Inflation drivers

Broad monetary growth and credit growth lead inflation by 12 months.

(average annual growth in percent)

Data: Pakistani authorities and IMF staff calculations.

To test these findings further, the study tracked the effects of increases in the wheat support price in 1999, 2003, and 2004. When the price was increased in 1999, monetary growth was subdued and inflation remained low. Pakistan experienced a slight increase in headline inflation in mid-2000, stemming from nonfood inflation, but this suggests that the wheat support price played only a small role, if any, in explaining headline inflation. In contrast, when the wheat support price increased in 2003 and 2004, monetary growth was high and increasing, which triggered nonfood inflation. Food inflation rose even more, which could reflect the additional impact of increases in the wheat support price. And, given the accommodating monetary conditions, there may indeed have been second-round effects from food to nonfood inflation.

Why is all of this important for Pakistan? The overarching objective of the State Bank of Pakistan should be price stability. High and persistent inflation is a regressive tax that hurts the poor. There is also evidence that inflation beyond a certain threshold hampers growth and financial sector development. For Pakistan, this threshold is estimated to be in the 3–6 percent range. Thus, the authorities’ medium-term inflation target of 5 percent is appropriate. In the future, monetary policy will need to focus foremost on keeping inflation close to this target.

Mohsin Khan and Axel Schimmelpfennig

IMF Middle East and Central Asia Department

Copies of IMF Working Paper No. 06/60, “Inflation in Pakistan: Money or Wheat?” are available for $15.00 each from IMF Publication Services. Please see pa. ge 176 for ordering details. The full text is also available on the IMF’s website (

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