Monetary Policy

1. MEANING of MONETARY POLICY:

The Monetary Policy which is made by Central bank or Federal Bank in order to control the supply of money is sometime also known as the Credit Policy. Following decisions are made in Monetary Policy: How much would be the supply of money in the economy? How much would be the ratio of interest? How much would be the viability of money? [Gaurav Akrani (2010) Monetary Policy- its meaning, definitions, objectives, Articles (http://kalyancity.blogspot.com/2010/09/instrumentsof-monetary-policy.html ,Accessed 8 November, 2011] Different economists have defined the term Monetary Policy in their own ways. Some of them are as follow: A policy employing the central banks control of the supply of money as an instrument for achieving the objectives of general economic policy is a monetary policy. (Prof. Harry Johnson) [St. Martin's, {1968-1969}, Surveys of economic theory. London: Macmillan, New York: 3 v. Nmero de Chamada: ma4cs AMERICAN ECONOMIC ASSOCIATION]. A policy which influences the public stock of money substitute of public demand for such assets of both that is policy which influences public liquidity position is known as a monetary policy. (A.G.Hart) [Max F. Millikan, Income stabilization for a developing democracy: a study of the politics and economics of high employment without inflation Volume 5 of Studies in national policy, Yale University] From the above definitions, it can be said that a monetary policy is made to control the demand and supply of money in the economy in order to achieve certain broad objectives.

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2. TYPES OF MONETARY POLICY 2.1. Expansionary Monetary Policy:

Expansionary monetary policy is a type of monetary policy which is used by the Federal bank to stimulate the National economy; in other ways we can say that to boost or expand the economic activities. By this policy, Federal bank lower the Federal Funds rate in order to increase the money supply. In this way mortgage rate decline, consumers borrow and spend more, and businesses grow, thereby hiring more workers who will consume even more.
Decreasing Interest Rates

(Kimberly Amadeo, Expansionary Monetary Policy)

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2.2. Contractionary Monetary Policy:

Contractionary monetary policy is a monetary policy which is used to put the brakes on the economy in order to stop the inflation. The central bank usually uses this policy to raise the fed funds rate. Under this policy the banks charge higher rate for borrowing funds from each other to meet the Federal Reserve requirement. When fed funds rate increases, the money supply decreases directly because banks would lend a less, and will not pay a higher fed funds interest rate. Due to higher fed funds rate means banks will increase variable rate mortgages, consumers will make use of less money, so will borrow and spend less, and businesses will stop to raise price, because demand will decrease. This usually heads off inflation.

Increasing Interest Rates Interest Rates

(Kimberly Amadeo, Contractionary Monetary Policy)

3. OBJECTIVES OF MONETARY POLICY:

The following are the main objectives for which the Central bank of a country uses certain tools of a monetary policy:

Full employment Neutrality of Money

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Exchange Rate Stability Equal Income Distribution Rapid Economic growth Price stability Balance of Payments(BOP) Equilibrium
3.1. Full Employment: After Keynes's publication of the "General Theory" in 1936 the concept of full employment was greatly discussed. Full employment refers to absence of involuntary unemployment. Straightforwardly we can say that 'Full

Employment' is a situation in which everyone who wants job gets the job or will get it. But it would not be meant that there is no unemployment, it will be at a very low rate. So, we can say that the full employment is never full. Monetary policy is used to attain the target of full employment. Monetary policy helps us in creating more jobs in different sector of the economy. 3.2. Neutrality of Money: According to the Economists such as Wicksted and Robertson, Money is considered as an inert factor. According to them, money should only play a role as a mean of exchange and not more than that. So, according to the thoughts of economists like Wicksted and Roberston the money supply can be controlled. Monetary imbalance always occurs because of the fluctuations in supply of money. The central bank of a country uses the tools of monetary policy to control the supply of money and neutralize the effect of money expansion in this sense. But this purpose of a monetary policy is always criticized because if money supply is put constant or unchanged then it will be difficult for us to gain price stability. 3.3. Exchange Rate Stability: When we express the price or currency of a home country in terms of any foreign currency then it refers to Exchange rate. If exchange rate is very

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unstable and is leading to continuous ups and downs in the exchange rate, the international community can lose confidence in our economy. The monetary policy is used to maintain the comparative stability in the exchange rate. 3.4. Equal Income Distribution:

Many economists also justify that Monetary policy can also be used to maintain economic equality. But in past few years economists have given the view that the monetary policy can play a complementary role in attainting an economic equality. Particular provisions can be made by monetary policy for the neglect supply such as agriculture, small-scale industries, village industries, etc. in order to provide them with cheaper credit for longer period. By applying these tools, it would be easy to come up. In past years, it had been seen that monetary policy had proved helpful in reducing economic inequalities among different sectors of society.

3.5. Rapid Economic Growth:

Rabid economic growth is one of the main purposes of a monetary policy. Economic growth can be influenced by monetary policy by controlling the real interest rate and its impact on the investment. The investment level can be encouraged in the economy by reducing the interest rate. For this the Central Bank makes a cheap or easy credit policy in order to reduce the interest rates. Increase in the investment level will lead to economic growth. Higher and rapid economic growth is possible if the monetary policy would be succeeded in maintaining income and price stability.

3.6. Price Stability:

All the economies endure the inflation as well as deflation. The main reason is the price instability. Both inflation as well as deflation is dangerous to the

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economy. The monetary policy is used to have price stability and to maintain the value of money stable. The aim is to reduce the income and wealth inequalities. In recession the monetary policy is used as an easy money policy but in inflation as a dear money policy.

3.7. Balance of Payments (BOP) Equilibrium:

Most of the developing countries have disequilibrium in the BOP. To maintain equilibrium in BOP the Central Banks use the tools of monetary policy. There are two aspects of BOP i.e. the BOP Surplus and BOP Deficit. BOP surplus refers to increase in money supply in the domestic economy, while the BOP deficit is the stringency of money. The BOP equilibrium can be achieved only, if the monetary policy is succeeded to maintain monetary equilibrium.

[Gaurav Akrani (2010) Monetary Policy- its meaning, definitions, objectives, Articles http://kalyan-city.blogspot.com/2010/09/instrumentsof-monetary-policy.html , Accessed 8 November, 2011]

4. TOOLS (INSTRUMENTS) OF MONETARY POLICY:

The development of the economy especially its financial sector derived that which of the tools of the monetary policy would be used by central bank. They are classified into two types. 1. Quantitative Methods 2. Qualitative Methods

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4.1 Quantitative Instruments or General Tools: The Quantitative Instruments are also called the General Tools of monetary policy. So, we can say that the Quantitative tools of credit control are also known as General Tools for credit control. These tools are indirect in nature and are intended to control the total volume of bank credit in the economy of any country. The general tool of credit control consists of following instruments. 4.1 1. Bank Rate Policy (BRP): The Bank Rate Policy (BRP) is one of the important quantitative tools of the monetary policy and is used for influencing the volume or the quantity of the credit in a country. The bank rate is a rate at which the Central Bank rediscounts bills of commercial banks in order to provide the advance to commercial banks against approved securities. The Bank Rate has its effects on the actual availability and the cost of the credit. If the bank rate is changed, the change in the cost of credit occurs that is available to commercial banks. If bank rate is increased by Central bank, consequently the volume of the commercials banks borrowings from Central bank will be decreased. The banks will avoid from further credit expansion because it becomes a more costly affair. On the other hand, the borrowings from Central bank will be easy for Commercial banks, if the Central Bank reduces the bank rate. This will enhance the credit creation. So, we can say that any change in the bank rate is normally brings about a resultant change in the lending rate and in the market rate of interest. However, the effectiveness of the bank rate being a tool of monetary policy depends on following things: Existing banking network Interest elasticity of investment demand Size and strength of the money market International flow of funds

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4.1.2. Open Market Operation (OMO): If the Central bank purchase or sale the short term and long term securities in open market, it refers to open market operation. This is very successful and famous instrument of the monetary policy. The OMO is used: To wipe out shortage of money in the money market To stimulate and affect the term and structure of the interest rate To soothe the market for government securities Commercial banks and other private organizations buy the securities of Central bank sell in the open market. Consequently, the existing money supply would be reduced because money gets transferred from commercial banks to the Central Bank. But when the CENTRAL BANK buys the securities from commercial banks in the open market, the existing money supply would be increased because money gets transferred from Central bank to commercial banks. So, we can say that the stock of money in the economy increases. This is the reasons why the actual stock of money gets changed by involvement of Central Bank in OMO transactions. In case of Inflation, the Central Bank sells securities in order to reduce the purchasing power. But in the recession or depression period, the Central bank purchase securities and makes more money available in the economy through the banking system. At the end, it can be said that buying and selling of securities under the OMO leads to change in the availability of credit in an economy. But there are certain things which affect OMO such as underdeveloped securities market, excess reserves with commercial banks, indebtedness of commercial banks, etc. 4.1.3. Variation in the Reserve Ratios (VRR): Certain proportion of their assets is kept in the form of Cash Reserves by Commercial Banks. Some part of these Cash Reserves is maintained in the Central Bank for the purpose of maintaining liquidity and controlling credit in

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an economy. These reserve ratios are called Cash Reserve Ratio (CRR) and a Statutory Liquidity Ratio (SLR). The ratio of commercial banks net demand and time liabilities which are maintained by commercial banks with Central Bank is called Cash Reserve Ratio (CRR). While the percentage or ratio of reserves which is maintained in the form of Gold or Foreign securities is known as Statutory Liquidity Ratio (SLR). Any change in the VRR (i.e. CRR + SLR) caused a change in commercial banks reserves positions or level. Commercial banks lending capacities can be affected by change in VRR. In case of Inflation CENTRAL BANK increases VRR in order to lower the purchasing power and credit creation. But when economy is facing recession or depression it lowers the VRR in order to make more cash reserves available for credit expansion. 4.2. Qualitative Instruments or Selective Tools: The Qualitative Instruments are also recognized as the Selective Tools of monetary policy. The qualitative tools are not directed to change the quality of credit or the use of the credit, as name shows that. They are actually used for making distinction or disparity between different uses of credit, such as favoring export over import or essential over non-essential credit supply. So, we can say, this method has impact over the lender and borrower of the credit. The Selective Tools of credit control consists of following instruments. 4.2.1. Fixing Margin Requirements: The "proportion of the loan amount which is not financed by the bank" is referred as Margin. In other words, it can be said that it is a part of a loan which a borrower raise to get finance for his purpose. If borrower has the Margin part, then she/he will be eligible to have a loan. So, there is a direct relation between a change in a margin and a change in the loan size. This method is very useful because we can make right amount of loan at right place. In simple words we can say that it is easy to encourage credit supply for the needy sector and discourage it for other non-necessary sector, by

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increasing margin for the non-necessary sectors and by reducing it for other needy sectors, under this qualitative tool. Example: - If the CENTRAL BANK realizes that more credit supply is needed to allocate in agriculture sector, then it will decrease the margin and even 85-90 percent loan can be given. 4.2.2. Consumer Credit Regulation Financial institutions regulate the consumer credit supply through hirepurchase and installment sale of consumer goods, under this qualitative tool of monetary policy. The down payment, installment amount, or loan duration, etc is fixed in advance by implying this method. This method can help us to check the credit use and then inflation in a country. 4.2.3. Publicity Publicity is another method of selective credit control. We do not need to be confused, Central bank is not going to do publicity like marketing tool of organization, Central Bank publishes different reports stating what is good and what is bad in the system. This published information is useful and helpful for commercial banks to direct credit supply in the desired sectors. Through its weekly and monthly bulletins, the Central Bank makes the information public. Commercial banks and other financial institutions can use this information for attaining goals of monetary policy. 4.2.4. Credit Rationing Credit amount to be granted by Central Bank are fixed. For credit rationing, The Fed limit the amount available to each commercial bank. So this method is also implying to control even bill rediscounting. Credit rationing can help in lowering banks credit exposure to unwanted sectors.

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4.2.5. Moral Suasion: Moral Suasion is the pressure exerted by the Central bank on the commercial and other banks for fulfillment or following the rules made by it, without taking strict actions. So, it can be said that it is just a suggestion to banks. It helps in limiting or restraining credit in the inflationary periods. Moral Suasion is made by informing the Commercial banks about the expectations of the Central Bank. Under moral suasion directives, guidelines and suggestions for commercial banks concerning about reducing credit supply for provisional aims are issued by Central bank. 4.2.6. Control through Directives Control through directives is a qualitative tool under which the Central Bank issue frequent directives or advice to commercial banks. These directives help the commercial banks in making their lending policy. By using this tool the Central Bank try to influence credit structures, supply of credit to certain limit for a specific purpose. The CENTRAL BANK do not issues directives to commercial banks for lending loans of sector such as securities, etc beyond a certain limit. 4.2.7. Direct Action Direct action refers to a monetary policy tool under which a Central Bank can make an action against a bank. The Central Bank can refuse to rediscount their bills and securities, if certain banks are not going to adhere to the CENTRAL Banks directives. CENTRAL BANK can also reject or discard the credit supply of those banks whose borrowings are in excess to their capital. Central Bank can punish a bank by changing some rates for it. At the end, the Central Bank can even put a ban on a particular bank if it is not following its orders and advices and is work against the objectives of the monetary policy, continuous.

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There is a diverse range of instruments of the monetary policy to be selected. But the success is limited due to the availability of alternative sources of credit in economy, Such as working of the Non-Banking Financial Institutions (NBFIs), profit motive of commercial banks and dictatorial nature off these tools. But to have desired results, a right mix of both the general and selective tools of monetary policy can be used. [Gaurav Akrani (2010) Instruments of Monetary Policy: Qualitative and Quantitative http://kalyan-city.blogspot.com/2010/09/instruments-of-

monetary-policy.html , Accessed 15 November, 2011]

5. EFFECTS OF MONETARY POLICY TO AN ECONOMY:

5.1. Consumption, Saving and Investment: The demand for consumption and savings of the people and the investment pattern of the businesses can be affected by changes in the real interest rates. For example, a decrease in real interest rate usually lowers the cost of borrowing, encourage people to borrow in order to make consumption (durable items like, electronic items, automobiles etc.). But a decrease in the real interest rate discourages savings which lead to more spending and aggregate demand. Stocks and other such type of investments become more desirable than bonds due to lower real interest rate. In simple words, we can say that People are likely to increase their stock of wealth. 5.2. Foreign Exchange, Imports and Exports: A lower interest rate leads to currency depreciation. So there would be lower prices of the home-produced goods selling abroad, which will make exports dearer and will discourage imports. This thing will lower the gap between imports and exports and a trade balance will be made by this effect. But on the other hand this leads the higher aggregate spending on goods and services produced in the country due to lower prices.

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5.3. Output and Employment: Production level increase and production cycle boosts up due to increase in aggregate demand for the output. This thing generates employment, and lead to more investments in that specific industry. The more employment and

increased investments accelerate the consumption further due to more incomes earned, thus attaining the multiplier effect of Keynes. 5.4. Inflation: Monetary policy has an impact on inflation in two ways. First is the indirect impact, for example economic activity will boost up if monetary policy able to achieve multiplier effect. Initiating labor and capital markets to raise outputs beyond there capacities and creating an upward pressure on wages, thus resulting inflation to rise (that is cost-push inflation). Thus there would be a trade-off between higher inflation and lower unemployment in the short-run which further accelerate inflation. As wages and prices start to rise they are hard to bring down back, stressing the need for early policy measures to be taken(World Defence Network).

Secondly, monetary policy has direct affect on inflation via future expectations and predetermined resultant factors. Like if people are expecting a rise in price level in future, they will be desirous to increase in wages, which in turn affect the prices and lead the higher inflation.

[World

Defence

Network

http://www.defence.pk/forums/economy-

development/13561-monetary-policy.html]

6. ROLE OF MONETARY POLICY:

Economists considered the monetary policy as the major defense against economic slowdowns. As compare to Fiscal policy (Made by Government/ Administration), monetary policy has an ability to act faster than to better

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judge the proper timing and extent of a stimulus. Fiscal stimulus usually imposes long-run costs on the economy without providing much short-run gain.

The Central bank can adjust and regulate monetary policy more quickly than the Fiscal policy made by Government or Administration. The timeliness response of the policy is mandatory because most of the contractions in economic activity last for only a few quarters. Fiscal policy in practice responds to changes in economic conditions with an extensive interval, because it takes time first to ratify a stimulus bill and then to put it into practice, and then takes time for increases tax reductions to reach the pockets of consumers. So, it can be stated that the effect of fiscal stimulus on household and business spending usually come too late.

The present economic condition, projections of future conditions as well as assessments of the risks to both economic activity and inflation going forward derives that whether and how much stimulus is needed. It is very difficult to forecast economic conditions and to determine the current condition of the economy, so this thing gives the limitations in the available data and in economists understanding of the world. But the Central Bank large and sophisticated team of analysts is better positioned to forecast the future economic conditions and determine the current conditions of the economy than any other agency of the federal government. The major reason is also that the Central Bank staff carries out this work independent of political considerations.

[Tax Policy Briefing Book: A Citizens' Guide for the 2008 Election and Beyond by the staff and affiliates of the Tax Policy Center,

Proceedings of New York University ... annual Institute on Federal Taxation, Volume 1; Volume 66]

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7. MONETARY POLICY FRAMEWORK IN PAKISTAN:

Considering the economic and financial market structure in Pakistan, State Bank of Pakistan (SBP) pursue the monetary policy with consideration of broad money supply (M2), in order to control the inflation without any prejudice to growth. The monetary policy is usually made at the start of the fiscal year. The State Bank of Pakistan (SBP) sets a target of M2 growth with government's targets of inflation and growth (usually in the month of May). By this coherent picture money demand in the economy can be estimated properly and easily. So, we can say that the basic idea is to keep the money supply close to its estimated demand level. A noteworthy excess or a shortfall may lead to substantial deviations in actual outcomes of inflation and real GDP growth. There are two strong assumptions underlying this framework: 1. First assumption is that there is a strong and reliable link between the goal variable (inflation or real GDP) and M2; and 2. Second, the Central Bank such as State Bank of Pakistan (SBP) can control growth in M2. The M2 growth close to its target level is the key reflection in the current monetary framework. But a here a pitfall is that composition of the money supply does matter and policy actions should be made at times even if these actions lead to a deviation in monetary growth from its target level. In other words it can be said that we need to take actions even if policy actions and set goals are going in opposite direction. Net

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foreign Assets (NFA) and Net Domestic Assets (NDA) of the banking system are the two main components of money supply.

NFA: When Foreign exchange inflows excess over outflows to baking

system, it refers to NFA. Simply we can say that NFA is a reflection of underlying trends in the country's external Balance of Payment (BOP) position. NFA is calculated or estimated by the anticipated values of all chief external transactions such as trade, workers' remittances; debt servicing, foreign investment, and debt flows etc.

NDA: As the name shows that the NDA of the banking system mainly
consists of credit to the government and the private sector, but not to any person or organization outside of the country boundaries. It present or shows the changes in the fiscal and the real areas of the economy, but in the case if is estimated as a residual of M2 and the NFA. Moreover, break-up of NDA is estimated on the basis of expected credit needs of the government and the private sector of the economy.

Reduction in NFA is usually considered as an injurious to the economic development. Sharp reduction NFA shows the deterioration Balance of Payment (BOP) position and a pressure on exchange rate. The reason is that in this case, a higher NDA growth, which although helps in expanding M2 to reach its target level, can further worsen external accounts, lead to higher depreciation of local currency, and higher reduction of country's foreign exchange reserves. Off course this thing is the indication of bad economic condition due to due to decrease in foreign exchange reserves.

FY07 is the indicative M2 growth target which is announced by State Bank of Pakistan (SBP). State Bank of Pakistan (SBP) has taken considerable contributing steps for monetary expansion while pursing this target. Further more, SBP has signed the relative changes in the monetary policy through

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adjustments in the policy discount rate (3-day repo rate) by considering the changes in monetary aggregates and other economic variables. The changes in the policy rate are anticipated and then made by liquidity management mainly through Open Market Operations (OMOs). The changes like Cash Reserve Requirement (CRR) and Statutory Liquid Reserve requirement (SLR) are also made."

8. EFFECTIVENESS OF MONETARY POLICY IN PAKISTAN:

Different economists have analyzed the importance of various channels that spread the monetary policy shocks in the real economy of Pakistan. According to an economist, Ahmed, credit channel is one of the most important mean for transmitting monetary policy actions to the real economic activities of a country. According to him, monetary policy shocks have minor or no effects on agriculture, mining, construction and ownership of dwelling sector. (2005) Historically, evidence has revealed that Pakistan is a high inflation and high interest economy which shows its economy inherent structural weaknesses. In 2000s when financial sectors in Pakistan began to expand in terms of market based money and foreign exchange markets, then the role and effectiveness in terms of success of monetary policy appeared more visible. In start of the 21st century, the weak monetary policies have resulted low growth and low twin deficits, along with structural measures to open up the economy. But in 2005, when inflationary pressure started to build up, monetary policy position was altered. At the end of the fiscal year, the economy which had been showing a constant growth since FY 01, registered a high level of growth ( 9 percent), average inflation rose sharply ( 9.3 percent) and the external current account balance turned into deficit ( -1.4 percent of GDP), due to alterations in the monetary policy. SBP has made its monetary policy strict after a prolonged gap due to domestic and global price pressure. But these efforts for reducing the inflation have dashed to the ground due to a

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rebound in international commodity prices and a rise in domestic food prices later on. SBP has made significant changes for implementations of the monetary policy due to complications of monetary management and adverse global and domestic economic developments.

9.

WHAT

NEEDS

TO

BE

DONE

TO

IMPROVE

THE

EFFECTIVENESS OF MONETARY POLICY?

SBP has made structural changes in the monetary formulation process and implementation in order to make its formulation and implementation more transparent, efficient, and effective. focused During the last few years SBP has on:

1-Institutionalizing the process of policy formulation and implementation. 2-Make efforts and movement towards a more market based credit allocation
mechanism.

3-Develop analytical and operational capacity of the monetary policy. 4- Improve capabilities of the policy to assess future developments to act
proactively. It means that makes or designs the policy tools by which we will be able to make predetermine calculations and results, foreseen

developments.

5-Improve upon the communication of policy stance to the general public.

The following areas are keys for effective monetary management, so we need to make attention in these areas. 1. Effectiveness of monetary and fiscal co-ordination would be helpful, so we can say that there will be more coordination more will be effective results and vice versa. Section 9A and 9B of the SBP Act (amended in 1994) stress the institutional mechanism for economic policy making (Monetary and Fiscal policy) and co-ordination of both policies. Monetary and Fiscal Policies Co-

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ordination Board (MFPCB) which established in February 1994 requires quarterly meetings in order to have a coherent picture. 2. Timely and quality information is very important for effective analysis of developments and policy making. But it have been seen that due to poor performance in the data collection and reporting mechanism of the different agencies of the country, information is usually not available with desired frequency and timeliness. As compared to many developed and developing countries, proper and timely data on quarterly GDP, employment and wages etc is not available in Pakistan. And also, the data on key macroeconomic variables (such as government expenditure and revenue, output of large-scale manufacturing, crop estimates, etc) is usually available with considerable gaps. 3. Unlike many other developed and developing countries, there is no set limit defined in the SBP Act or the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005 on government to borrow from State Bank of Pakistan (SBP). In high inflation government borrowing from SBP also complicates the process of liquidity management. Therefore, the primary task to improve the effectiveness and efficiency of monetary policy is to prohibit or limited the practice of government borrowings from the SBP by making some rule. For this we need to make amendments in the SBP Act and the FRDL Act 2005. 4. Another issue which we usually face in the making and implementing the monetary policy a clear distinction between exchange rate management and monetary management. We need to make a clear cut distinction between both of them. It is a general perception that the State Bank is restricted to keep the exchange rate at some predefined level and any fluctuation below or above this level would be an inefficiency of State Bank of Pakistan (SBP).

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At the end we can say that it is not impossible to solve all these problems immediately. It needs a deeper structural reforms and time to handle these issues. [The Effectiveness of Monetary Policy in Pakistan ARTICLE (December 09 2008: The speech of the Governor, State Bank of Pakistan, at the Institute of Business Management on December 6].

http://www.defence.pk/forums/economy-development/17538effectiveness-monetary-policy-pakistan.html

10. HISTORICAL OVERVIEW OF MONETARY POLICY IN PAKISTAN:

In Pakistan monetary policy is used in co-ordination with the fiscal policy for achieving the objectives of macro-economic stability and higher economic growth. The government supervises monetary situation of country with the help of State Bank of Pakistan (SBP). During the decade of fifties, external balances in the economy were corrected by monetary policy. In this era, for preventing inflation in the economy government followed the tight monetary policy. But because of deficit financing supply of money was increased in the economy. During the sixties the phenomenon of monetary expansion continued. Main actions taken into account because of increase in GDP rate (6.8% in 1960s) and private investment were increase in bank rates; cash reserve requirements, liquidity ratios, elimination of credit quotas and the imposition of credit ceiling etc. For working against inflation government tried to control the supply of money in the economy because of conflict with India in 1965 and crop failure in 1966. It would be important to state that inflation rates remained low (3.8%, annual average) during this period. This was due to steps taken by the monetary authorities (e.g. increase in bank rates; cash reserve

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requirements, liquidity ratios, elimination of credit quotas and imposition of credit ceiling). Monetary assets in Pakistan (annual average) 1 Stock of money (Rs billion) Growth rate (%) 7.8** 16.3 21.0 13.2 15.95 1950s 1960s 1970s 1980s l990s 5.16 13.29 41.10* 180.9 785.0

Source: Gap, Economic Survey. Various Issues. During the seventies devaluation of currency gave rise to the general price level. Public and private borrowings were also the cause of increase in money supply. State Bank took various steps for controlling money supply but achieved limited success. In eighties financing through external borrowings and bank sources resulted in increase indebtedness but also led to inflation in the economy (approximately 12.5% during 1981-1982).During the period of 1983-90 government resorted to non-bank borrowings as a major source of financing the public deficit. Because of this action inflation remained under control (6.0% on average) during 1983-90. Lack of domestic resources and shortage of foreign loans forced the government to take loan from World Bank. During the 1990s, the government introduced various financial reforms of monetary management. The main features of these reforms are: Increase in reserve requirements, license to establish private commercial banks, privatization of commercial banks, greater financial autonomy to the SBP, increase in commercial lending rates, credit control and capital market

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reforms etc.

Due to these financial reforms certain non-bank borrowing

instruments were suspended. During nineties, the stock of money has grown up enormously; its growth rate was about four times higher than the preceding decade. During the recent years government had tried to control the money supply through various means. Meddling in monetary policy is usually indicative of government failure in fiscal arena. Hence, there is a strong need for correcting the fiscal sinfulness in Pakistan. By Dr. M. Hanif Akhtar, Aug 28 - Sep 03, 2000 Department of Commerce, B. Z. University, Multan

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11. CURRENT MONETARY POLICY PAKISTAN: STATE BANK OF PAKISTAN

MONETARY POLICY DECISION 30 November 2011

In FY12 SBP reduced its policy rate by 200 bps, to 12 percent. The objective of this stance is to support private investment in the economy even with a constraining global and domestic economic environment. The main factor of this stance was the expectation of average CPI inflation remains within the announced target in FY12. In pursuing this stance SBP recognize the risks to macroeconomic stability drive from fiscal weaknesses and falling foreign investment. These include recovery of medium term inflationary pressures and challenges SBP is facing in maintaining foreign exchange reserves and managing market liquidity. Re-examination of latest developments and projection show that during the last two months macroeconomic risks have increased. For instance, in October 2011, the year-on-year CPI inflation place at 11 percent and during the first four months of FY12, the month-on-month inflation averaging at around 1.3 percent per month, show the inflationary pressures. The examine of commodity level CPI data expose that the CPI items exhibiting year-on-year inflation of more than 10 percent is constantly increasing and almost all items belong to non-food category. For the next wheat procurement season government has increased its wheat support price by RS100 to RS1050 per 40 kg. The targeted inflation rate is 12 percent for FY12, which is shown uncertain to come down to a single digit level in FY13. The government borrowing from the banking system is the major determinant of inflation. Energy crisis is also a hurdle in the effective utilization of

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productive capacity and adding to the high inflation-weak growth problem. The earlier comfortable external current account position for FY12 has become less benign, which has helped SBP in lowering its policy rate. The actual external current account deficit of $1.6 billion for the first 4 months of FY12 is higher than the previous expected deficit for the year. The main reason for this is the rising trade deficit. International oil prices of $110 per barrel and growth in non-oil imports have kept the total import growth close to $3.4 billion per month. Unstable global economic outlook is also a challenge faced by the external sector.

Higher financial inflows are required by larger external current account deficit in FY12 to maintain foreign exchange reserves. The total net direct and portfolio inflows during July-October, FY12 were $207 million and net outflow was $113 million in official loans. SBPs liquid foreign exchange reserves have declined to $13.3 billion at the end of October 2011 as compared to $14.8 billion at the end of June 2011. The reduction of RS115 billion in the Net Foreign Assets (NFA) of SBPs balance sheet during 1 July to 18 November 2011 reflects the external current account deficit and declining financial inflows. SBP has to provide significant liquidity in the system, at least to the level of compensating for the declining NFA, for meeting the economys demand for money. The excellent amount of liquidity injected by SBP through its Open Market Operations (OMOs) is Rs340 billion on 28 November 2011. The main source of demand for money and liquidity injected by SBP is government borrowings from banking system. Government has borrowed Rs255 billion from scheduled banks and Rs62 billion from SBP to finance its current years budget deficit during 1 July to 18 November, 2011 except the issuance of government securities of Rs391 billion for settling its debt and commodity loans. Government is the main user of systems liquidity and banks remain uncertain to credit to the private sector.

Efforts of lowering the level of liquidity injections have implications for settling the payments in the interbank market, is an important consideration for SBP

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to maintain financial stability. The marginally increasing trend of these injections carries inflationary risk, which is not according to the objective of achieving and maintaining price stability. There are three solutions to the price and financial stability considerations and supporting private investment in the economy. First, the government needs to ensure that all the budgeted foreign inflows occur as soon as possible. This will reduce the pressure on the BOP and bring fresh rupee liquidity in the system. Second, the government should initiate a comprehensive tax system which broadens the tax base of the economy. This thing has a significant importance to reduce the governments borrowing from the scheduled banks. Third, efforts are required to improve financial deepening and increase competition in the banking system.

The last of these solutions is on which SBP is actively working. For instance, SBP is encouraging depositors to invest in government securities through Investors Portfolio Securities (IPS) accounts for promoting competition in the banking system and offer different sources of saving to people. Saving deposits or investments in IPS accounts provide tough competition to banks forcing them to offer better returns on deposits. This thing encourages savings and control the circulation of money. Moreover, it will also improve the transmission of monetary policy. This strategy will also expand the governments funding source, extend the secondary market of government securities and assist the issuance of corporate debt. Finally, it should also be recognized that there are uncertainties involved in grasping the benefits of these measures. These uncertainties have adverse effects on SBPs efforts to support private sector and investment in the economy. Therefore, after giving a great consideration to the need to stimulate growth and rising risks to macroeconomic stability, the Central Board of Directors of SBP has decided not to change policy rate and keep it at its existing rate which is 12 percent.

State Bank of Pakistan http:// sbp.org.pk

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12. CONCLUSION:
From studying whole the report we concluded that monetary policy is very necessary and beneficial for the growth of an economy. It enables Central Bank to act faster according to economic conditions and take steps for the welfare of economy. But the conduct of monetary policy is very complex. It has not only to be forward looking but also to tackle the uncertain future. The challenge of monetary policy is to balance the various choices into a coherent whole and to formulate policy as an art of the possible.

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REFERENCES:
Dr. M. Hanif Akhtar, Aug 28 - Sep 03, 2000 Department of Commerce, B. Z. University, Multan Gaurav Akrani( 2010) Monetary Policy- its meaning, definitions, objectives, Articles http://kalyan-city.blogspot.com/2010/09/instrumentsof-monetary-policy.html , Accessed 8 November, 2011 Gaurav Akrani( 2010) Instruments of Monetary Policy: Qualitative and Quantitative http://kalyan-city.blogspot.com/2010/09/instruments-of-

monetary-policy.html , Accessed 15 November, 2011 Kimberly Amadeo, Expansionary Monetary Policy Kimberly Amadeo, Contractionary Monetary Policy Max F. Millikan, Income stabilization for a developing democracy: a study of the politics and economics of high employment without inflation Volume 5 of Studies in national policy, Yale University St. Martin's, [1968-1969], Surveys of economic theory. London: Macmillan, New York: 3 v. Nmero de Chamada: ma4cs AMERICAN ECONOMIC ASSOCIATION. State Bank of Pakistan http:// sbp.org.pk Tax Policy Briefing Book: A Citizens' Guide for the 2008 Election and Beyond by the staff and affiliates of the Tax Policy Center,

Proceedings of New York University ... annual Institute on Federal Taxation, Volume 1; Volume 66 The Effectiveness of Monetary Policy in Pakistan ARTICLE (December 09 2008: The speech of the Governor, State Bank of Pakistan, at the Institute of Business Management on December 6.

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http://www.defence.pk/forums/economy-development/17538effectiveness-monetary-policy-pakistan.html World Defence Network http://www.defence.pk/forums/economydevelopment/13561-monetary-policy.html

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