Money, Inflation, and Growth in Pakistan

Abdul Qayyum
Pakistan Institute of Development Economics (PIDE)

Pakistan Development Review, Vol. 45, No. 2, pp. 203-212, Summer 2006

Abstract:
This paper attempts to investigate the linkage between the excess money supply growth and
inflation in Pakistan and to test the validity of the monetarist stance that inflation is a monetary
phenomenon. The results from the correlation analysis indicate that there is a positive association
between money growth and inflation. a. The important finding from the analysis is that the excess
money supply growth has been an important contributor to the rise in inflation in Pakistan during
the study period, thus supporting the monetarist proposition that inflation in Pakistan is a
monetary phenomenon. This may be due to the loose monetary policy adopted by the State Bank
of Pakistan to show the high priority of the growth objective. The important policy implication is
that inflation in Pakistan can be cured by a sufficiently tight monetary policy. The formulation of
monetary policy must consider development in the real and financial sector and treat these
sectors as constraints on the policy.

Number of Pages in PDF File: 10

Keywords: Money Supply, Inflation, Growth, Quantity Theory, Monetary Policy, Pakistan

How Inflation is Measured

There are two main indices used to measure inflation. The first is the Consumer Price
Index, or the CPI . The CPI is a measure of the price of a set group of goods and services

The second measure of inflation is the Producer Price Index, or the PPI . While the CPI
indicates the change in the purchasing power of a consumer, the PPI measures the change
in the purchasing power of the producers of those goods. The PPI measures how much
producers of products are getting on the wholesale level, i.e. the price at which a good is
sold to other businesses before the good is sold to a consumer. The PPI actually combines
a series

Causes of inflation

It has been generally agreed by the economists that high rates of inflation and
hyperinflation are caused by an excessive growth in the supply of money

Inflation and its impact on the Pakistan economy

Posted on June 16, 2009 by Raheem

Changes in the exchange rate and the prices of goods and services

By Parveen Zaiby

Inflation is the rise in the prices of goods and services in an economy over a
period of time. When the general price level rises, each unit of the functional
currency buys fewer goods and services; consequently, inflation is a decline in the
real value of money — a loss of purchasing power in the internal medium of
exchange, which is also the monetary unit of account in an economy. Inflation is a
key indicator of a country and provides important insight on the state of the
economy and the sound macroeconomic policies that govern it. A stable inflation
not only gives a nurturing environment for economic growth, but also uplifts the
poor and fixed income citizens who are the most vulnerable in society.

Definition of Monetary Policy . What are Main Objectives of

Monetary Policy ? Discuss its Instruments and Technique for
Credit Control .

>> NOVEMBER 13, 2009

Definition of Monetary Policy

Monetary policy is that part of economic policy in which central

bank controls the cost and supply of money and credit by
applying different techniques. It is also
main function of central bank.
We all know, if supply and cost of money are not controlled.
Then both are harmful for development of economy. In India
RBI is sole institute who is taking steps to regulate money and
credit by controlling its supply. Monetary policy regulates both
volume and value of currency and credit.
Objective of Monetary Policy

• To control the supply of money.

• To control the cost of money and credit.
• Exchange stability
• Full employment

Instruments or technique of credit control / monetary policy:-

1. Bank Rate

Bank rate is that rate which is charged by Central bank for issue loan to
the member banks. By changing it, central bank can control the credit.

→ If Central bank increase this bank rate, all commercial banks will
increase their interest rate by this loan become costly and flow of fund in
the form of credit will decrease.

→ If central bank wants to expand credit, then Central bank will

decrease bank rate, after this commercial bank can get advance and
loan at cheap rate and by this way, they also decrease their interest
rate. After this flow of cash in the form of loan will increases.

2. Open Market Operation

Open market operation is the all action which is done by central bank for
purchase and sale of member banks' security in open market. If RBI
wants to contract the credit, then RBI will sell the security of member
bank and member bank's flow of cash will stop. If RBI wants to expand
credit in recession, then RBI will start to buy the security of member
banks and member banks get cash and they can now use it for
providing more loans to customers.

3. Cash Reserve Ratio / Statutory minimum reserve:-

Cash reserve ratio is the minimum percentage of the deposit to be kept

as reserve by the banks with central bank. It can be used as the
technique of monetary policy. By changing cash reserve ratio, RBI can
contract or expand credit in Indian economy.

→ If RBI wants to contract credit, and then RBI will increase this ratio.
After this all banks have to keep more fund as reserve with RBI. So,
they will decrease the amount of loan due to decrease the total fund
available for enterprises.

→ If RBI wants to expand credit, then RBI will decrease this ratio, after
this all banks have to keep less fund as reserve with RBI. So, they will
issue more credit to public.

4. Changes in Marginal Requirement of loan:-

Marginal requirement is the difference between value of security and

actual loan accepted by bank. Suppose a person wants to take loan of
Rs. 80 , we has to give security of Rs. 100 then marginal requirement is
Rs. 100 - Rs. 80 = Rs. 20 .

→ If RBI wants to contract the credit , this rate will increase suppose , if
RBI fixes it as 40 % , then customer can get loan of Rs. 60 after giving
security of Rs. 100 . So , trend of getting loan will decrease .
→ If RBI wants to expand the credit, this rate will decrease suppose, if
RBI fixes it as 10% more people will take loan , if they get Rs. 90 in
cash after giving security of Rs. 100 .

So , by this way RBI controls credit .

5. Moral Persuasion / Inspiration

RBI as central bank of country can control credit with moral persuasion.
Under this persuasion, RBI can call a meeting of all commercial bank
and give advice in discussion that they should not give loan for
speculative purposes.

6. Rationing of Credit

RBI has right to create ration of credit under monetary policy. It can be
done by following way:-

• To fix the amount of loan for a particular bank.

• To fix Quota for all banks.
• To fix Quota for different traders.

7. Regulation of consumer credit

→ In case inflation, prices are increased. To control prices central bank

contract credit to reduce the total amount of installment for payment.

→ In case of deflation, prices are decreased to control prices central

bank expand credit to increase the amount of installment.
money supply

Definition
The total supply of money in circulation in a given country's economy at a given
time. There are several measures for the money supply, such as M1, M2, and
M3. The money supply is considered an important instrument for controlling
inflation by those economists who say that growth in money supply will only lead
to inflation if money demand is stable. In order to control the money supply,
regulators have to decide which particular measure of the money supply to
target. The broader the targeted measure, the more difficult it will be to control
that particular target. However, targeting an unsuitable narrow money supply
measure may lead to a situation where the total money supply in the country is
not adequately controlled.

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