Monetary policy is how a central bank acts in its economic environment. A central bank is a national (or, in the case of the European Central Bank, a supranational) institution. Mostly the primary goal is to maintain price stability. Another common goal is to support the economy if it does not inhibit the achievement of price stability to a risky extent. This chapter examines what different costs arise due to inflation (increasing prices) and why it makes sense to keep inflation at a moderate level, to maintain price stability respectively

1. Monetary PolicyMonetary Policy
Monetary Policy in Pakistan

2. Group MembersGroup Members
Joher Javed RajwanaJoher Javed Rajwana MBE-12-02MBE-12-02
Rana Zaheer AbbasRana Zaheer Abbas MBE-12-12MBE-12-12
Muhammad MoazzamMuhammad Moazzam MBE-12-20MBE-12-20
Zohaib IrshadZohaib Irshad MBE-12-35MBE-12-35
Khurram ehsanKhurram ehsan MBE-12-45MBE-12-45
Shahid SaeedShahid Saeed MBE-12-59MBE-12-59

3. Joher Javed RajwanaJoher Javed Rajwana
MBE-MBE-112-042-04
Introduction of Monetary PolicyIntroduction of Monetary Policy

4. What is Monetary Policy?What is Monetary Policy?
The term monetary policy refers to actions taken
by central banks to affect financial conditions.
Monetary Policy operates variables such as
money supply, interest rates and availability
of credit.
Monetary Policy ultimately operates through its
influence on expenditure flows in the economy.
In other words affects liquidity and by affecting
liquidity, and thus credit, it affects total demand in
the economy.

5. MONETARY POLICYMONETARY POLICY
Monetary Policy is the process by which the
Central BankCentral Bank manages the money supply to
achieve specific goals e.g. Controlling
inflation ,maintaining an exchange rate
achieving full employment & GDP growth .
Monetary policy refers to the measures
which the central bank of the country takes
in controlling the money and credit supply in
the country with a view to achieving certain
specific economic objectives.

6. Definitions of Monetary PolicyDefinitions of Monetary Policy
“Monetary policy determines the amount of
money that flows through the economy.”
(Chad Brooks)
“Monetary policy consists of the methods
by which governments regulate theInterest
rate nations' banking systems and the money
supply. The framework in which monetary
policy exists consists of policy institutions,
policy mandates and targets, and policy
instruments, such as open market
operations and banking reserves.” ( Shane

7. MACRO - ECONOMIC POLICY
CONSISTS of MONETARY POLICY and
FISCAL POLICY.
The objective of MACRO - ECONOMIC
policy is to have sustainable GDP GROWTH
while containing INFLATION and achieving
an acceptable rate of UNEMPLOYMENT.
The fact that GDP rises or falls shows that
BUSINESS CYCLES are unavoidable and
MACRO-ECONOMIC policy can never
really conquer them.

8. GDP GROWTH.GDP GROWTH. Country's annual output and of goodCountry's annual output and of good
and services. Same as economic growth.and services. Same as economic growth.
UNEMPLOYMENT.UNEMPLOYMENT. The number of people of workingThe number of people of working
age without a job as a percentage of the workforce.age without a job as a percentage of the workforce.
IINFLATIONNFLATION.. Rising prices across the board. MonetaristsRising prices across the board. Monetarists
(Milton Friedman) believed it is a monetary phenomena. To(Milton Friedman) believed it is a monetary phenomena. To
stabilize prices the rate of growth of money supply needs to bestabilize prices the rate of growth of money supply needs to be
carefully controlled.carefully controlled.

9. There is a trade off between INFLATION
and UNEMPLOYMENT.
The lower the UNEMPLOYMENT
RATE the higher is the INFLATION
RATE. Governments have to choose
between the two evils.
Too much GDP growth will cause an
increased rate of inflation called
overheating in the economy which can
lead to a recession and a hard landing.

10. State Bank of Pakistan (SBP)State Bank of Pakistan (SBP)
The Central Board consists of nine members: the Governor (who is
Chairman), the Secretary, Finance Division, Government of Pakistan –
and seven Directors, including one Directors from each Province, to be
nominated by the Federal Government ensuring representation to
agriculture, banking and industrial sectors. The Directors are appointed
for terms of up to three years.
◦ Chairman : Yaseen Anwar ( Governor SBP)
◦ Dr. Waqar Masood Khan (Secretary Finance)
◦ Zaffar A. Khan
◦ Mr Qamar Beg
◦ Asad Umar
◦ Waqar A. Malik
◦ Sahar Z. Babar –
Corporate Secretary SBP(Secretary to the Central Board)

11. Rana Zaheer AbbasRana Zaheer Abbas
MBE-12-12MBE-12-12
Aims/Objectives of Monetary Policy

12. Aims/Aims/Objectives of Monetary PolicyObjectives of Monetary Policy
The goals of monetary policy are to promote
maximum employment, stable prices and moderate
long-term interest rates.
The core objectives of Pakistan’s monetary policy
are to control inflation, maintaining price stability,
strong monetary growth and achieving maximum
employment rate

13. 1. Exchange Stability:-
2. Control of Inflation and
Deflation:-
3. Economic Development:-
4. Increase in the Rate of
employment:-
5. Improvement in Standard of
Living:-

14. 7.Eliminating Inflationary and7.Eliminating Inflationary and
recessionary gaprecessionary gap
 When the economy is operating at a level which is greater than full
employment it is called inflationary gap
 When the actual GDP line is above the potential GDP line the
economy is said to have a positive output gap as at the peak point.
Aggregate Demand exceeds the potential capacity thus shortages occur
and prices rise (inflation) also called an inflationary gap.
 Factors of production such as labor, land and capital are fixed in the
short run, and wages can not change. Therefore the inflationary gap
will remain in the short run.

15. Recessionary GapRecessionary Gap
 When the actual GDP line is below the potential GDP line
the economy has a negative output gap as in a
recession. At this point there is spare capacity, higher then
average unemployment leading to less inflationary
pressures in the aggregate economy. Also called
a recessionary gap. We can relate this concept back to
the Real GDP data

16. Muhammad MoazzamMuhammad Moazzam
MBE-12-20MBE-12-20
Tools of Monetary PolicyTools of Monetary Policy

17. Monetary Policy Tools /Monetary Policy Tools /
InstrumentsInstruments
To accomplish its monetary policy objective, the
Central Bank can use a mix of direct and indirect
policy tools to influence the supply and demand of
money.
Following are the tools of Monetary policy
1.Reserve Requirement
2.Open market operations
3.Discount Rate (Bank Rate)

18. Reserve RequirementReserve Requirement

19. Reserve RequirementReserve Requirement
Requirements regarding the amount of
funds that banks must hold in reserve
against deposits made by their customers.
RR is Defined as the % of the bank total
deposit from households that must be kept
on reserve at central bank
Example: when RR 20% and deposits are
one Billion

20. The Question Arises here HowThe Question Arises here How
this Affect the supply of money inthis Affect the supply of money in
the economy?the economy?

21. Open market operationsOpen market operations
OMOs involve buying (outright or temporary) and
selling of Govt securities by the central bank, from
or to the public and banks.
The conduct of open market operations refers to
the purchase or sale of government securities by
the Bank to the banking and non-banking public.
The SBP uses open market operations as its primary
tool to influence the supply of bank reserves. This
tool consists of Federal Reserve purchases and sales
of financial instruments, usually securities issued by
the Government ( SBP).

22. Open market operationsOpen market operations
Government Security
Control Money Supply
Investment
Employment Opportunities
Cost of Borrowing IRn Sm1 Sm2
Control Inflation
IR
IR2 Dm
Qm

23. Discount Rate (Bank Rate)Discount Rate (Bank Rate)
Discount rate is the rate of interest
charged by the central bank for providing
funds or loans to the banking system.
Raising Bank Rate raises cost ofcost of
borrowingborrowing by commercial banks, causing
reduction in credit volume to the banks,
and decline in money supply
Funds are provided either through
lending interest rateinterest rate or rediscounting
or buying commercial bills

24. Discount Rate policy toolsDiscount Rate policy tools
These tools are used to establish limits on
interest rates, credit and lending. These include
interest rate credit control, interest rate
interest rate control and interest rate lending
to banks as lender of last resort, but they are
rarely used in the implementation of monetary
policy by the Bank.
Interest rate controls
Credit controls
Lending to commercial banks

25. Interest rate controlsInterest rate controls The Bank has the power to
announce the minimum and maximum rates of interest and
other charges that commercial banks may impose for specific
types of loans, advances or other credits and pay on deposits..
Credit controlsCredit controls The Bank has the power to control the
volume, terms and conditions of commercial bank credit,
including installment credit extended through loans, advances
or investments.
Lending to commercial banksLending to commercial banks The Bank may provide
credit, backed by collateral, to commercial banks to meet
interest rate short-term liquidity needs as lender of last
resort.

26. Zohaib IrshadZohaib Irshad
MBE-12-35MBE-12-35
Impact of Monetary policy inImpact of Monetary policy in
EconomyEconomy

27. Impact of Monetary policy inImpact of Monetary policy in
EconomyEconomy
Change in money supply
Change in interest rate
Change in desired investment

28. Change in money supplyChange in money supply
 The money supply is the total amount of monetary
assets available in an economy at a specific time
 Change in Money Supply = (1/reserve ratio) *
(Initial Change in Excess Reserves)
3 Tools to Change Money Supply:
 Open-market operations (buying and selling treasury bonds,
notes, and bills).
 Discount rate: Interest rate banks are charged when they
borrow from the SBP.
 Reserve requirement: % of deposits that must be held by a
bank as vault cash or on account with the federal reserve.

29. The relationship between MoneyThe relationship between Money
Supply and the rate of interestSupply and the rate of interest
higher demand for money will push up
interest rate making it more attractive for
banks to supply credit
higher Interest rate may attract deposits
from oversees
Higher Interest rate may encourage
depositors to control money supply In the
economy

30. Change in interest rateChange in interest rate
 An interest rate is the rate at which interest is paid by
borrowers for the use of money that they borrow from
a lender
 Interest-rate targets are a vital tool of monetary policy and
are taken into account when dealing with variables
like investment, inflation, and unemployment
 The central banks of country generally reduce interest rates
when they wish to increase investment and consumption in
the country's economy
 The average inflation for 2013 is projected to remain
between eight and nine per cent, well within the target of
9.5%.
 Country GDP growth was expected to remain 4% during the
current financial year.

31. Reasons for interest rateReasons for interest rate
changeschanges
 Political short-term gain
 Deferred consumption
 Inflationary expectations
 Liquidity preference
 Taxes

32. Change in desired investmentChange in desired investment
 Monetary policy can be restrictive (tight), accommodative
(loose) or neutral (somewhere in between).
 When the economy is growing too fast and inflation is
moving significantly higher, the central bank may take steps
to cool the economy by raising short-term interest rates,
which constitutes restrictive or tight monetary policy.
 when the economy is slow- growth, the central bank will
adopt an accommodative policy by lowering short-term
interest rates to inspire investment and get the economy
back on track.
 The impact of monetary policy on investments is thus
direct as well as indirect. The direct impact is through
the level and direction of interest rates, while the indirect
effect is through expectations about where inflation is
headed.

33. Syed Khurram EhsanSyed Khurram Ehsan
MBE-12-45MBE-12-45
Types of monetary policyTypes of monetary policy

34. Types of monetary policyTypes of monetary policy
Monetary policy affects a nation’s monetary
supply and the direction of its economy.
Central bankers have different types of
policy actions at their disposal, and they can
use these in an expansionary or
contractionary manner, depending on
economic conditions.
Contractionary or restrictive
monetary policy takes place if it reduces
the size of the money supply. It can also
occur with the raising of interest rates.

35. Contractionary / TightContractionary / Tight
monetary policymonetary policy
“Tight monetary policy, also called
contractionary monetary policy, tends to
curb inflation by contracting/reducing the
money supply”
slow economic growth with the high
interest rates
Borrowing money becomes harder and
more expensive, which reduces spending
and investment by both consumers and
businesses

36. Expansionary /Easy monetaryExpansionary /Easy monetary
policypolicy
“Easy monetary policy, also called
expansionary monetary policy, tends to
encourage growth by expanding the money
supply”
The cost of borrowing money goes down in
hopes that spending and investment will go
up.

37. Targets for monetary policy:Targets for monetary policy:
Employment, economic growth, and
inflation can not control directly, it must
choose settings, or targets, for variables that
it can control in order to best achieve its
goals
In practice, there are two types of targets:
1. Inflation targets.
2. Price level targets.

38. Inflation targetingInflation targeting
The inflation target is achieved through periodic
adjustments to the Central Bank interest rate
target. The interest rate used is generally the
interbank rate at which banks lend to each other
overnight for cash flow purposes. Depending on
the country this particular interest rate might be
called the cash rate or something similar.
The interest rate target is maintained for a specific
duration using open market operations. Typically
the duration that the interest rate target is kept
constant will vary between months and years. This
interest rate target is usually reviewed on a
monthly or quarterly basis by a policy committee.

39. Price level targetingPrice level targeting
Price level targeting is similar to inflation
targeting except that CPI growth in one year
over or under the long term price level target is
offset in subsequent years such that a targeted
price-level is reached over time, e.g. five years,
giving more certainty about future price increases
to consumers. Under inflation targeting what
happened in the immediate past years is not
taken into account or adjusted for in the current
and future years.

40. Monetary aggregatesMonetary aggregates
In the 1980s, several countries used an
approach based on a constant growth in the
money supply
This approach is also sometimes called
monetarism
Most monetary policy focuses on a price
signal of one form or another, this approach
is focused on monetary quantities.

41. Fixed exchange rateFixed exchange rate
 This policy is based on maintaining a fixed exchange rate
with a foreign currency. There are varying degrees of fixed
exchange rates, which can be ranked in relation to how
rigid the fixed exchange rate is with the attach nation
 Under a system of fiat fixed rates, the local government or
monetary authority declares a fixed exchange rate but does
not actively buy or sell currency to maintain the rate
 Under a system of fixed-convertibility, currency is bought
and sold by the central bank or monetary authority on a
daily basis to achieve the target exchange rate
 Under a system of fixed exchange rates maintained by a
currency board every unit of local currency must be
backed by a unit of foreign currency (correcting for the
exchange rate)

42. Gold standardGold standard
The gold standard is a system in which the
price of the national currency is measured in
units of gold bars and is kept constant by
the daily buying and selling of base currency
to other countries and nationals
The gold standard might be regarded as a
special case of the "Fixed Exchange Rate"
policy. And the gold price might be regarded
as a special type of "Commodity Price
Index".

43. Shahid SaeedShahid Saeed
MBE-12-59MBE-12-59
Advantages and disadvantages of
monetary policy
SummarySummary

44. Advantages of monetary policyAdvantages of monetary policy
11. Low Inflation:. Low Inflation: The two goals of monetaryThe two goals of monetary
policy are to promote maximum sustainable levelspolicy are to promote maximum sustainable levels
of economic output and foster a stable price system.of economic output and foster a stable price system.
Stable prices mean keeping inflation low, and theStable prices mean keeping inflation low, and the
Federal Reserve Bank of San Francisco concedesFederal Reserve Bank of San Francisco concedes
that low inflation is all that monetary policy canthat low inflation is all that monetary policy can
achieve in the long run. Inflation reduces theachieve in the long run. Inflation reduces the
purchasing power of money, harming economicpurchasing power of money, harming economic
growth. In contrast, stable prices enable householdsgrowth. In contrast, stable prices enable households
and businesses to make financial decisions withoutand businesses to make financial decisions without
worrying about sudden, unexpected price increasesworrying about sudden, unexpected price increases

45. 2.Political Independence:2.Political Independence:
When central banks operate free of political pressures,When central banks operate free of political pressures,
they are free to make policy decisions based onthey are free to make policy decisions based on
economic conditions and the best available data oneconomic conditions and the best available data on
economic performance, rather than short-termeconomic performance, rather than short-term
political considerations imposed by elected officials orpolitical considerations imposed by elected officials or
political parties.political parties.
3.3.Household spending: in normalin normal
conditions, interest rates have a direct and powerfulconditions, interest rates have a direct and powerful
effect on effect on household spending
whenwhen Interest rate (High) spending (Low)Interest rate (High) spending (Low)
Interest rate (Low) spending (High)Interest rate (Low) spending (High)

46. Disadvantages of monetaryDisadvantages of monetary
policypolicy
1. Raising interest ratesRaising interest rates Raising interest rates can
negatively affect on investment spending and the housing market,
and the exchange rate and hence the balance of payments
2.2. Dual economyDual economy There is also the problem of
the dual economy - are high rates set for the booming service
sector, or low rates for the depressed manufacturing and export
sector
3.3. Time LagTime Lag monetary policy actions take time to work
their way through the economy, an estimates that monetary
policy actions to affect output and employment can take three
months to two years for their effects to be felt. Actions may

47. 4. Liquidity TrapsLiquidity Traps Interest rates may fall to very low
levels during a deep recession, and while the demand for
credit may rise, the supply may become trapped in the system,
known as the liquidity trap
5.5. Conflicting GoalsConflicting Goals Central banks can use
monetary policy to achieve low inflation in the long run and
affect economic output and employment in the short run.
these goals sometimes conflict. Reducing interest rates to
expand the money supply and stem rising unemployment rates
during a recession

48. Summary of Monetary PolicySummary of Monetary Policy
 As is true for monetary policy is intended to achieve price
stability, full employment within the full employment-
unemployment rate definition, and economic growth.
 The Central Banks' most important assets are stock
securities and loans to commercial banks.
 Central monetary policy are that the Govt can use
monetary policy to stop rapid inflation and to push the
economy away from depression.
 Nearly all economists consider that monetary policy is an
important tool for economic stability
 The limitationslimitations of central bank monetary policy are that
global economy considerations make monetary policy more
difficult to administer and the outcome much less certain