Monetary Policy of Pakistan

Preview
What is monetary policy and its objectives.
Tools to manipulate monetary policy.
Difference

between
expansionary
and
contractionary monetary policy and its
effects.
Defining quantitative easing.
Comparison
of
monetary
policies
implemented since the creation of Pakistan.

Monetary Policy
The actions of a central bank that determine

the size and rate of growth of the money

supply, which in turn affects interest rates.
Objectives:
1. Price Stability
2. Promote savings or investments thus
economic growth
3. Keep
the
countrys
exchange
rate
competitive

Tools to Manage the Monetary Policy

Qualitative Methods
1. Changes in margin requirements
2. Moral Suasion
. Quantitative Methods
1. Changes in bank rate/discount rate
2. Open market operations (OMOs)
3. Changes in cash reserve ratios (CRR)
4. Changes in liquidity ratio
5. Credit rationing

Expansionary Monetary Policy

A policy which expands (increases) money supply in the

economy.
Options include purchasing government securities on the open
market, lowering the discount rate and reserve requirements.
These measures will directly impact the interest rates.
Prices of securities are inversely related to the interest rates.
When the central bank buys government securities, the prices
of these securities increase which result in a decrease in
interest rates.
Lowering the discount rates will decrease interest rates
leading to higher levels of capital investment and less saving.
Lowering reserve requirements would leave commercial banks
excess money which they can invest or lend.

Expansionary Monetary Policy

Lower interest rates make domestic securities

less attractive, so the demand for domestic

securities falls and the demand for foreign
securities rises.
The demand for domestic currency falls and
the demand for foreign currency rises, causing
a decrease in the exchange rate. (The value of
the domestic currency is now lower relative to
foreign currencies)
A lower exchange rate causes exports to
increase, imports to decrease and the balance
of trade to increase.

Expansionary Monetary Policy

Used in situations to deal with slow growth,

reduced
aggregate
demand
and
high
unemployment.
By lowering interest rates, the central bank
would increase aggregate demand.
High growth is a likely consequence with GDP
growth
positive,
increased
government
spending, decreasing unemployment but
higher inflation rates.

Contractionary Monetary Policy

A policy which contracts (decreases) the money supply in the

economy.
Options include selling government securities on the open
market, increasing the discount rate and reserve requirements.
These measures will directly impact the interest rates.
Prices of securities are inversely related to the interest rates.
When the central bank sells government securities, the prices
of these securities decrease which result in an increase in
interest rates.
Increasing the discount rates will increase interest rates leading
to lower levels of capital investment and more saving.
Increasing reserve requirements would leave commercial banks
less money which they can invest or lend.

Contractionary Monetary Policy

The higher interest rates make domestic securities

more attractive, so the demand for domestic

securities rises and the demand for foreign securities
falls.
The demand for domestic currency rises and the
demand for foreign currency falls, causing an
increase in the exchange rate. (The value of the
domestic currency is now higher relative to foreign
currencies)
A higher exchange rate causes exports to decrease,
imports to increase and the balance of trade to
decrease.

Contractionary Monetary Policy

Used in situations to deal with high inflation or

anticipated inflation.
By raising interest rates, the central bank
would slow down aggregate demand.
A recession is a likely consequence with GDP
growth negative and an increase in
unemployment.

Quantitative Easing
Unconventional

monetary policy, which is

implemented by the central bank to stop
money supply falling when standard monetary
policy becomes ineffective.
Implemented by buying financial assets from
commercial banks to increase the monetary
base.
When short term interest rates are close to
zero, standard monetary policy can no longer
reduce interest rates. Quantitative easing is
then used by purchasing longer term financial
assets thereby lowering longer term interest

Quantitative Easing
It is used to ensure that inflation does not fall

below the target.

Could lead to higher inflation in the future
because of increased money supply.
Will not be effective if the central bank does
not lend out the additional reserves.

Monetary Policy 1948-1959

Adoption of monetarist approach regarding

price stability.
One of the objectives was to develop the
financial sector especially the banking
system.
Up to 1960, monetary expansion was on
account of credit to the government sector.
The private sector was small, and banks were
conservative in lending.
Deficit financing was the major source of
changes in money supply as compared to
lending to the private sector.

Monetary Policy 1948-1959

Demand for credit from the public sector

emanated from the following:

1. Need for liquidity in the economy.
2. Governments
heavy
expenditure
for
infrastructure.
3. Pakistan Industrial Development Corporation
(PIDC) was setup to make investment
projects when the private sector was
hesitant.
4. Funds for commodity operations.

Monetary Policy 1960-1972

Beginning

phase
of
liberalization
and
deregulation.
Demand for credit in the private sector
increased.
High
growth rates of investment and
production.

Choice of Policy Instruments 1948-1972

Interest Rate Policy
1. Initially bank credit formed a small percentage of GDP so

2.

.
.
.

the effects of changes in interest rates were unlikely to

be substantial. Only meaningful change in 1959 3%-4%.
Up to 1972 State Bank believed that changes in interest
rates would adversely affect the level of investments.
Bank rates were changed twice. From 4% to 5% in 1965
and 5% to 6% in 1972.
Selective Credit Controls
Quota System and Cash Reserve Requirements
Relative price stability from 1955-1972. Only 10%
increase in general price levels.

Monetary Policy 1972-1988

Creation

of National Credit Consultative

Council (NCCC) and Annual Credit Plan, 1972.
Regimes of credit ceilings with effect from
October 1973.
Targets for fixed investment and exports.
Control on bank deposits and lending rates.
GDP growth rate 6.58%, inflation 7.22% and
monetary expansion 15.02%

Choice of Policy Instruments 1972-1988

Interest Rate Policy
1. State Bank became more flexible as interest
2.
.
1.

rates eventually increased to 10%

Lending rates to banks also increased.
Selective Credit Controls
Direct flow of credit to selected sectors to
prevent building of inventories of daily use
commodities.
Statutory Liquid Ratio (SLR) increased to
35%.

Monetary Policy 1988-1999

Transition from credit ceilings to reliance on

OMOs.
Increase in reserve requirements and
commercial lending rates.
Average GDP 4.3%, inflation 10%, inflationary
gap 11%
Decline in capital inflows due to worsening
law and order situation
Paks credibility with IFIs declined as it
defaulted on IMF and World Bank agreements.

Monetary Policy 1999-2005

Ensuring growth without price stability.
OMOs and discount rates used but no effect

as the central bank was under government

influence.
Contractionary policy was implemented to
defend the exchange rate as rupee was
falling.
However towards the end of the period
interest rates were lowered and a more
expansionary approach was adopted
GDP growth rate 5.23% and monetary
expansion 15.1%.

Monetary Policy 2005-2008

During this period when inflation reached 11%

contractionary
policy
was
mainly
implemented.
The monetary policy was tightened as
discount rates were raised and overall CRR as
well as SLR were increased.
OMOs used to drain out excess liquidity.
A balanced growth rate and price stability was
the main objective.

Monetary Policy 2008-2013

The objective was to strike a balance between

stabilization and recovery.

Ceilings were implemented on government
borrowing.
Interest rates went up to 14% but to support
economic activity they started to lower
towards the end of 2009.
CRR and SLR were raised.
GDP growth was 2% and inflation stood at 20.
77%.
Monetary expansion was 9%.

Current Monetary Policy

Currently contractionary policy employed with discount

rates being raised to 9.5% to contain inflationary pressures.

Inflation is expected to be in double digits contributing from
removal of subsides from the energy sector, high
government borrowing from State Bank and increase in
sales tax. Furthermore there is a decline in domestic and
foreign investments.
Economists see the rise in interest rate strange because
industrial growth was picking up and see this move as a
consequence of the deal with IMF.
There is an argument that increase in interest rates will
reduce government borrowing freeing up space for private
sector borrowing.