final money and banking (2)
TRANSCRIPT
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Monetary Policy
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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/instruments-of-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
inflationVolume 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:
AfterKeynes's publicationof the "General Theory" in 1936the 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 Roberstonthe 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 forthe 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, Articleshttp://kalyan-city.blogspot.com/2010/09/instruments-
of-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 thenon-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 hire-
purchase 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 helpfulfor 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 ofM2 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 ofM2 and the NFA. Moreover, break-up ofNDA 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 higherNDA 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 andimplementation in order to make its formulation and implementation more
transparent, efficient, and effective. During the last few years SBP has
focused 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 needto 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 Act2005.
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/17538-
effectiveness-monetary-policy-pakistan.html
10. HISTORICAL OVERVIEW OF MONETARY POLICY INPAKISTAN:
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 offifties, 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 reserverequirements, 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 1950s1960s1970s 1980sl990s
Stock of
money
(Rs billion)
5.16 13.29 41.10* 180.9 785.0
Growth rate (%) 7.8** 16.3 21.0 13.2 15.95
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, Articleshttp://kalyan-city.blogspot.com/2010/09/instruments-
of-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
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St. Martin's, [1968-1969], Surveys of economic theory. London:
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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,
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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.
http://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://www.google.com.pk/search?tbo=p&tbm=bks&q=bibliogroup:%22Studies+in+national+policy%22&source=gbs_metadata_r&cad=7http://www.google.com.pk/search?tbo=p&tbm=bks&q=inauthor:%22Yale+University%22&source=gbs_metadata_r&cad=7http://www.google.com.pk/search?tbo=p&tbm=bks&q=inauthor:%22Yale+University%22&source=gbs_metadata_r&cad=7http://www.google.com.pk/search?tbo=p&tbm=bks&q=bibliogroup:%22Studies+in+national+policy%22&source=gbs_metadata_r&cad=7http://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.htmlhttp://kalyan-city.blogspot.com/2010/09/instruments-of-monetary-policy.html -
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World Defence Network http://www.defence.pk/forums/economy-
development/13561-monetary-policy.html
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