EFFECT OF

MONETARY POLICY
ON THE ECONOMY OF
PAKISTAN

Submitted To: Sir Ahsan Shakil

GROUP MEMBERS:
ZIAD ASGHAR

B-16703

WALEED BIN AAMIR

B- 18992

SAIF UD DIN AHMED

B-18993

EFFECT OF MONETARY POLICY ON THE

ECONOMY OF PAKISTAN
What is Monetary Policy?
Monetary policy is how central banks manage the money supply to guide healthy
economic growth. This policy is adopted by the central bank of an economy in
order to control and regulate the money supply often altering or interest rate to
ensure price stability and general trust in the currency. It also deals with the both
the lending and borrowing rates of interest of the banks.
Objectives of Monetary Policy:
1) Price Stability or Control of Inflation:
Monetary policy is better suited to the achievement of price stability that is,
containing inflation. Price stability means reasonable rate of inflation.
2) Economic Growth:
It is the most important objective of a monetary policy. The monetary policy can
influence economic growth by controlling real interest rate and its resultant impact
on the investment.
3) Full Employment:
Full employment has been ranked among the foremost objectives of monetary
policy. It is an important goal not only because unemployment leads to wastage of
potential output, but also because of the loss of social standing and self-respect.

4) Exchange Rate Stability:

Exchange rate is the price of a home currency expressed in terms of any foreign

currency. The monetary policy aims at maintaining the relative stability in the
exchange rate. The RBI by altering the foreign exchange reserves tries to influence
the demand for foreign exchange and tries to maintain the exchange rate stability.
Types of Monetary Policies used in Pakistan:
1) Expansionary Monetary Policy
Expansionary monetary policy is appropriate when the economy is in recession and
unemployment is the problem. The goal of expansionary monetary policy is to
reduce unemployment. Therefore the tools would be an increase in money supply.
To increase the money supply the federal government can:
1) By government bonds
2) Lower the interest rate
3) Lower the reserve ratio

2) Contractionary Monetary Policy

Contractionary monetary policy is appropriate when the economy is in expansions
and inflation is a problem .The goal of contractionary monetary policy is to reduce
inflation. Therefore the tool would be the decrease in the money supply.
To decrease the money supply the Federal Reserve can:
1) Sell government bonds
2) Raise the interest rate
3) Raise the reserve ratio

Effect of Monetary Policy on Pakistans Economy:

Under the Monetary Policy, when the interest rates in Pakistan are increased it has
effects on both Borrowing as well as Deposit. When the interest rates are higher on
Borrowing, it means that that a normal layman doing a business will increase the

prices of its goods or services in order to overcome the higher rate of interest thus
it would result in an increase in inflation all over the country .
Similarly, it would have also have a significant impact on Deposits. Higher interest
rate on deposits means that it would encourage more number of people to store
their money in banks. It would attract a huge number of foreign investors thus
foreign investments would increase in Pakistan resulting in an overall
improvement in the economy of our country. The objective of monetary policy in
Pakistan, as laid down in the SBP Act of 1956, was to achieve the targets of
inflation and growth set annually by the government. On September 12, 2015 The
State Bank of Pakistan announced the new monetary policy for the next two
months reducing the interest rate further by 50 basis points. The central bank
reduced interest rate by 0.5 percent and brought it down to six percent. In line with
market expectations, the State Bank of Pakistan (SBP) decided to keep the policy
rate unchanged at 6% for the next two months. The policy rate is the benchmark
interest rate that helps determine the general cost of borrowing in the economy.
The SBP uses this monetary policy tool to achieve price stability and economic
growth targets. Lower interest rates put more borrowing power in the hands of
consumers and when consumers spend more, the economy grows, naturally
creating inflation. This reduction in interest rates by the State Bank of Pakistan is
an example of Expansionary Monetary Policy. Expansionary monetary policy is
used in Pakistan when the economy is in recession and unemployment is the
problem. It lowers the interest rates which increase the money supply as more
people now borrow money from the banks. It proves to be a significant factor in
regulating money in the country. Contractionary monetary policy is used in
Pakistan when the inflation is at its peak. In order to control inflation and rising
economy the interest rates are increased. This rising interest rates in turn will
encourage people to save more and borrow less thus reducing the amount of money
in circulation in the market. Lesser money in the market makes it difficult to buy
the goods and services thus slowing down the rise in price. Central bank in
Pakistan tend to either maintain or increase the benchmark interest rate at a time
when inflation is expected to rise. One of the major objectives of the monetary
policy in Pakistan is to encourage foreign investments which would in turn
improve the economy of the country. The monetary policy is implemented in a
way that ensures there is decent interest rate on deposits so that more and more

foreign businessmen and investors start investing their money in Pakistan which
definitely has a positive impact on the economy of Pakistan.