Monetary policy aims to manage a country's money supply and interest rates to achieve goals like low inflation and full employment. The document discusses the objectives, tools, and transmission mechanisms of monetary policy. It also provides examples of monetary policy in Pakistan between 2000-2014, noting the SBP has used tools like adjusting policy rates and reserve requirements in response to economic conditions like inflation, growth, and balance of payments. The challenges facing Pakistan's monetary policy are also summarized.

2. Definition
• Monetary policy is
concerned with deciding
how much money the
economy should have or
perhaps more correctly
deciding whether to
increases or decrease
the purchasing power of
money.”
• ” According to Macconal:
“Changing the money
supply to assist the
economy to achieve a
full employment”.

3. • Monetary policy is the process of managing a nation's money supply to
achieve specific goals such as constraining inflation, achieving full
employment or more well-being. Monetary policy can involve setting
interest rates, margin requirements, capitalization standards for banks or even
acting as the lender of last resort or through negotiated agreements with other
governments”.
• A wide variety of policy systems are possible to conduct monetary policy
operations, but in the current international scenario, we have two broad
groups of countries.
• The first one is the group of those countries (like Hong Kong, Zambia, and
China, etc.), whose monetary policies are focused primarily on the exchange
rate.
• The second is the group of countries with floating exchange rates (like the
United States of America, Japan, Pakistan and Australia, etc.) and monetary
policy involves the management of short-term interest rates by central banks
to pursue the macroeconomic objectives of the economy.

4. What are the objectives of monetary
policy?
• The objectives of
monetary policy are to
promote maximum
employment, stable
prices and moderate
long-term interest rates.
By implementing
effective monetary
policy, the Fed can
maintain stable prices,
thereby supporting
conditions for long-term
economic growth and
maximum employment.

5. How it is used by the central bank?
• Contractionary policy
• The Central Bank designs Contractionary policy or Tight
monetary policy in order to constrain the growth of money,
tends to curb inflation by contracting/reducing the money
supply (i.e. increasing inflation) and credit in the economy.
• Expansionary policy
• Expansionary policy or Easy monetary policy is used as a tool
by the central bank to broaden the monetary base and credit in
the economy by reduction in interest rates and increase in bond
prices to tends to encourage growth by expanding the money
supply.

6. Tools of Monetary Policy
• In order to attain the
objectives discussed above,
the central bank uses three
tools: open market
operations, the discount rate
and reserve requirements.. All
three affect the amount of
funds in the banking system.

7. The discount rate
The discount rate is the interest rate Reserve Banks charge commercial banks for short-
term loans. Federal Reserve lending at the discount rate complements open market
operations in achieving the target federal funds rate and serves as a backup source of
liquidity for commercial banks. Lowering the discount rate is expansionary because the
discount rate influences other interest rates. Lower rates encourage lending and
spending by consumers and businesses.
Reserve requirements
Reserve requirements are the portions of deposits that banks must hold in cash, either in
their vaults or on deposit at a Reserve Bank. A decrease in reserve requirements is
expansionary because it increases the funds available Reserve requirements
Open Market Operations
Open market operations involve the buying and selling of government securities. The
term “open market” means that the Fed doesn’t decide on its own which securities
dealers it will do business with on a particular day. Rather, the choice emerges from an
“open market” in which the various securities dealers that the Fed does business with –
the primary dealers – compete on the basis of price. Open market operations are
flexible, and thus, the most frequently used tool of monetary policy.

8. How does Monetary Policy affect the
economy of a country?
• Changes in the real interest rates affect the demand for
consumption and savings of the people and also change the
investment pattern of the businesses.
• For instance, a reduction in real interest rate lowers the cost of
borrowing, encouraging people to borrow in order to consume
(durable items like, electronic items, automobiles etc.
• Lower real interest rates also make stocks and other
such investments more desirable than bonds, resulting
stock prices to rise. People are likely to increase their
stock of wealth.

9. • Foreign Exchange, Imports and Exports
Short-run changes lower interest rate result as currency
depreciation, which means lower prices of home-produced
goods selling abroad, making exports dearer and discourage
imports, reducing the gap between imports and exports and
having favorable balance of trade. Again this leads to higher
aggregate spending on goods and services produced in the
country.
• Output and Employment
The increase in aggregate demand for the output boosts
up the production cycle; generating employment, as a
result increase investment spending on the existing
industrial capacity. Which accelerate the consumption
further due to more incomes earned, thus attaining the
multiplier effect of Keynes.

10. How does Monetary Policy affect
Inflation?
• Monetary policy affects inflation in two ways. First, affecting
indirectly, if monetary policy able to achieve multiplier effect, it
boosts up economic activity. Initiating labor and capital markets
to raise outputs beyond there capacities and creating an upward
pressure on wages, thus resulting inflation to rise (that is cost-
push inflation). Thus there would be a trade-off between higher
inflation and lower unemployment in the short-run which further
accelerate inflation. As wages and prices start to rise they are
hard to bring down back, stressing the need for early policy
measures to be taken.
• Secondly, monetary policy can directly affect inflation via future
expectations. Like if people expect the rise in prices in future,
they persuade to increase in wages, which in turn affect the
prices, resulting higher inflation

11. Monetary policy in Pakistan
Various Monetary policy of SBP in different years In 2000-01
With the free fall of the Rupee in mid-September 2000, SBP
had to tighten its monetary policy to defend the exchange
rate In 2001-02 The tight monetary discipline visible in FY01
was perceptibly eased in FY02. In2002-03 a substantial
increase in the annual external account surplus and the
easier monetary stance of the SBP left the money market
wash with liquidity during FY03. In 2004-05 During FY04
the thrust of monetary management was towards aligning
the market expectations with monetary policy stance. Initially
during FY04 when interest rates were under downward
pressure.

12. • In 2005-06 April 2005 in response to the headline when
inflation reaching at 11.3%, SBP remains in monetary
tightening phase In 2006-07During July-April 14, net credit to
private sector grew by Rs266.4 billion (or 12.6 %) against Rs
339.7 billion (or 19.8 %) in the corresponding period of FY05
Despite liquidity in the system In 2007-08 SBP will be closely
monitoring the economic developments and outlook for FY07
and will take appropriate actions as and when required in
pursuit of maintaining the objective of price stability without
prejudice to economic growth. Various Monetary policy of SBP
in different years.

13. • In 2008-09The tight monetary policy was continued by
SBP under the macroeconomic stabilization
Programme and discount rate was raised by 200 bps on
13 November 2008 resulting in cumulative increase of
300 bps. In 2009-10 The overall level of risk and
uncertainty in the economy has increased and the
pressure on the fiscal position, has escalated and
growth in the real economy is limited. Striking a
balance between monetary and financial stability SBP
has decided to support the recovering real economic
activity Therefore, effective 25th November, 2009, the
SBP policy rate will be lowered by 50 bps to 12.5
percent Various Monetary policy of SBP in different
years.

14. • In 2013-14 the monetary policy statement of February 2013, the
SBP highlighted two main challenges for monetary policy to
manage the balance of payment position and to contain the
possible increase in inflation. A cumulative decline of 450 basis
points in the policy rate of SBP since the beginning of FY12 has
played a role in this uptick. Moreover, an analysis of the balance
sheets of the main sectors supports this assessment. In
conclusion, given the risks to the balance of payments position,
the Central Board of Directors of SBP has decided to keep the
policy rate unchanged at 9.5 percent. Various Monetary policy
of SBP in different years

15. • In 2014 (March) Almost all major economic indicators have moved in the
desired direction over the past few months. Inflation has come down and
growth in Large Scale Manufacturing (LSM) has been strong. Similarly,
the fiscal deficit has been contained during the first half of the of concern
for some time, have increased noticeably. In conclusion, given the risks
to the balance of payments position, the SBP’s Board of Directors has
decided to keep the policy rate unchanged at 10.0 percent. Fiscal year
while the private sector credit has increased. Moreover, reflecting positive
sentiments prevailing in the market, the fiscal authority has been able to
borrow long term and rupee has appreciated against the US dollar.
Above all, the foreign exchange reserves of SBP, a key source Various
Monetary policy of SBP in different years
• SBP has encountered difficulties to targeting the inflation, economic
growth, employment and interest rate objectives. But still there are
certain difficulties which are a huge hindrance in the way of Economic
Policy. So SBP can control all hurdles with some suitable policies.
• (A) Improve its capacity to forecast liquidity conditions and actively
preempt inflationary pressures.
• (b) Develop a greater understanding of the channels of transmission of
monetary policy.
• (c) Have an increasingly transparent policy framework.

16. Conclusion
• The results show that mostly developing countries fail to
attain the desired goals of monetary policy. The basic
hurdles are the deep debt burdens on government, and
inflation pressures. Like, Pakistan, although adopted tight
monetary policy, stood at actual inflation rate of 7.7% (FY
2006-07), against the inflation target of 6.5% (in FY 07).
However, the monetary policy plays effective role to
control the money supply in economy in the short-run for
a sustainable prosperous long-term growth of developed
countries.