Policies adopted by any country’s Central Bank that influence interest rates and credit conditions, which in turn, influence consumer and business spending, is termed as “Monetary Policy”. Monetary policy is amongst the key tools which a Government uses to influence its economy. The government with its authority to control the supply of money in the economy, it influences the overall level of economic activity which are formulated keeping in mind the political objectives. The objectives primarily are:

Low inflation,

Low unemployment,

A positive balance of payment, and

Economic growth.

A “Central Bank” appointed by the Government usually controls the monetary policy.

Many economists believe that monetary policy is a far more powerful tool than fiscal policy for controlling inflation. It involves changing the value of the exchange rate which results in fluctuations in the currency and have a strong impact on the macroeconomic activity such as incomes, output levels, prices, etc.

Changing short term interest rates affect the expenditure and savings behavior of mainly households and businesses over time and are feed through the circular flow of spending and income. Monetary policy works with great consideration of time lags which result on the interest elasticity of demand for various goods and services.

MONETARY POLICY OF PAKISTAN

In line with trends world-wide, Pakistan adopted liberal and market-oriented monetary policies and procedures. This involved a move to indirect tools of monetary policy management and a major departure from the age-old practice of relying on direct interventions, such as liquidity reserve ratios and credit ceilings and controls.

Accompanying this policy change were gradual changes to the legal and institutional framework of monetary policy formulation, its targeting and operating procedures as well as development of infrastructure for treasury operation to allow for effective open market operations.

These changes have had a subtle but profound impact on monetary management which in turn has impacted economic management of Pakistan. Like in several other places, there however remains a level of ignorance regarding the virtues and technicalities of monetary policy management and there is a debate on some key issues. Structuralisms doubt whether monetary policy has any significant impact, in particular on price stability. Frustrations are also evident among different economic players who are forced to change their behaviors and expectations in line with tighter monetary discipline and interest rate adjustments. There is less understanding and patience for the lagged effects of monetary policy to defuse the inflationary pressures or to ease the liquidity conditions.

Monetary policy of Pakistan now for some years has been largely supportive of the dual objective of promoting economic growth and price stability. It achieves this goal by targeting monetary aggregates (broad money supply growth as an intermediate target and reserve money as an operational target) in accordance with real GDP growth and inflation targets set by the Government.

The given uncertainties concerning the fiscal sectors present that stance of monetary policy is striking a difficult balance between reducing inflation, ensuring financial stability, and supporting the recovery of the economy. An upward adjustment in the State Bank of Pakistan’s policy rate, at this point in time projects the risk of blocking and severely hindering the still emerging recovery whereas a downward adjustment projects the risk of fuelling an already high inflation.

HOW MONETARY POLICY IS USED AS A TOOL TO MANIPULATE/BOOST THE ECONOMY

Monetary policy has two different facets. There is either an expansionary or a contractionary monetary policy. In an expansionary policy the supply of money in the economy is increased so that there is a boost in the economy. On the other hand, a contractionary monetary policy aims at decreasing the level of money supply in the economy. Contractionary monetary policy according to the State Bank of Pakistan also aims on increasing the supply at a slower pace than otherwise. An expansionary policy may be put into action to control factors such as unemployment. This is done through decreasing interest rates.

In eras of a boom when inflation is taking place the State Bank of Pakistan may make use of a contractionary policy, in which it increases the interest rates, therefore making investment a much more feasible option for the people. This decreases the amount of money rolling in the market. This happens in a way in which the final product is that the amount of money changing hands decreases, because saving money is at such times a much more feasible option for the people.

The State Bank of Pakistan also dictates what the minimum balance requirement is for the banks. This is a crucial factor and also one of the most important factors when it comes to reducing the supply of cash in the economy.

The policies and the stance that the state bank takes in relation to the imports and exports of the country also differ from time to time.

EFFECT OF MONETARY POLICY ON ECONOMY

Monetary policy is one of the fundamental tools of government used to stabilize the economy, it’s a process through which government or the central bank i.e. State Bank of Pakistan control or administer the supply of money in the economy. Monetary policy works on the expansion and Contraction of investments and is associated with consumption and expenditure. The impact of monetary policy on economy basically regulates the flow of money in the economy, & to control inflation, the goal of monetary policy is to excel economic growth without the change in price level.