Acknowledgments

April 2nd 2010

From Tariq Raza

While writing this case study I have assistance form many persons. I am
grateful for this assistance. I would specially like to thank the following
persons who took the time to share their ides and criticism with me.

Mr. Nouman Jamil (COO) CWCD

Mr. Ali Raza Head Agri Finance Fysal Bank CWCD

I also wish to express my sincere thanks to Mr. Mahtab who offered

valuable suggestions for this case Study

Tariq Raza

Roll No: AD514226

MBAIT (2nd Semester)

Abstract:

Monetary policy is one of the tools that a national Government uses to

influence its economy. Using its monetary authority to control the
supply and availability of money, a government attempts to influence
the overall level of economic activity in line with its political objectives.
Usually this goal is "macroeconomic stability" - low unemployment, low
inflation, economic growth, and a balance of external payments.
Monetary policy is usually administered by a Government appointed
"Central Bank", the Bank of Canada and the Federal Reserve Bank in
the United States.

Central banks have not always existed. In early economies, governments

would supply currency by minting precious metals with their stamp. No
matter what the creditworthiness of the government, the worth of the
currency depended on the value of its underlying precious metal. A coin was
worth its gold or silver content, as it could always be melted down to this. A
country's worth and economic clout was largely to its holdings of gold and
silver in the national treasury. Monarchs, despots and even democrats tried
to skirt this inviolate law by filing down their coinage or mixing in other
substances to make more coins out of the same amount of gold or silver.
They were inevitably found out by the traders, money lenders and others
who depended on the worth of that currency.

Modern monetary policy does not involve gold to a great extent. In 1968,
the United States rescinded its promise to pay in gold and effectively
removed itself from the "gold standard". Since then, it has been the job of
the Federal Reserve to control the amount of money and credit in the U.S.
economy. I doing this, it wants to maintain the purchasing power of the U.S.
dollar and its comparative worth to other currencies. This might sound easy,
but it is a complex task in an information age where huge amounts of money
travels in electronic signals in microseconds around the world.
Table of Contents:

Topic Page No

Introduction to the Topic 4-10

Practical Study of the Organization 11-12

Data Collection Methods: 13-14

Technologies used within organization 15-18

SWOT Analysis 19-22

Conclusion 23

Recommendations 24

References 25
Monetary policy
Monetary policy is one of the tools that a national Government uses to
influence its economy. Using its monetary authority to control the
supply and availability of money, a government attempts to influence
the overall level of economic activity in line with its political objectives.
Usually this goal is "macroeconomic stability" - low unemployment, low
inflation, economic growth, and a balance of external payments.
Monetary policy is usually administered by a Government appointed
"Central Bank", the Bank of Canada and the Federal Reserve Bank in
the United States.

In the 1800s, even commercial banks in Canada and the United States
issued their own banknotes, backed by their promises to pay in gold. Since
they could lend more than they had to hold in reserves to meet their
depositors demands, they actually could create money. This inevitably led to
"runs" on banks when they could not meet their depositors’ demands and
were bankrupt. The same happened to smaller countries. Even the United
States Treasury had to be rescued by JP Morgan several times during this
period. In the late 1800s and early 1900s, countries legislated their
exclusive monopoly to issue currency and banknotes. This was in response
to "financial panics" and bank insolvencies. This meant that all currency was
issued and controlled by the national governments, although they still
maintained gold reserves to support their currencies. Commercial banks still
could create money by lending more than their depositors had placed with
the bank, but they no longer had the right to issue banknotes.

Monetary policy is a short-run tool used by the central bank to persist

sustainable economic growth (in the long-run) by controlling the money
supply through open market operations, discount lending and reserve
requirements.

“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 central bank uses monetary policy in two ways: that is Contractionary
monetary policy or expansionary monetary policy.

The Central Bank designs Contractionary policy in order to constrain the

growth of money (i.e. increasing inflation) and credit in the economy. This is
done by an increase in interest rates and a decrease in bond prices, such
that higher interest rates lead to lower levels of capital investments, and
leading the demand for bonds (domestic) to rise. The appreciation of
domestic currency causes exchange rate to rise so there would be an
increase in the demand for domestic currency and fall in demand for foreign
currency. Thus a higher exchange rate causes a decline in exports and the
imports get dearer in the country.

Danny L. McDaniel said

24 February, 2009 at 6:08 pm

Monetary policy as an economic instrument has no traction. Interest

are low as they can go, unless the Fed decides to peg them in negative
categories. What needs to happen is to have the Fed do actually the
opposite of conventional thinking and start ratcheting up rates. Many
Americans earn income off interest and higher rates would generate
more money for those people.

Currently, the real estate market is stagnate. Those who are fortunate
to buy property have the money to invest in the market and can pay
an additional amount. The economic game is not a zero-sum
proposition.

Higher interest-rates, and not lower rates, seems to be the only free-
market mechanism that can start to pull the economy out its
doldrums, and not massive bailouts that seem to evaporate in value
when handed over to state governments and financial institutions.

For too long businesses and governments have over-promised

monetary benefits to employees and retirees. We have to scale back
and reconfigure the American economic system, government thinking,
and the rudimentary way Americans live their lives. It will take
 courage from elected officials and the American people. But it seems
that everyone has been promised something which no one is will to
give it up. The United States has literally reached its’ tipping point.

In the present international scenario, due to hike in inflation internationally,

most of the countries adopted Contractionary policy, like Pakistan recently
has increased interest rate by 0.5 percent and set 10 percent short-term
interest rates, and it is expected that the Reserve Bank of Australia (RBA)
would increase short-term interest rates from 6.25 percent to 6.50 percent.

On the other hand Expansionary 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. The reduced interest rates attract
capital investments and increased bond prices reduces its demand and the
demand for foreign bonds to rise. The exchange rate also lowers down as a
result of fall in the demand for domestic currency and a rise in demand for
foreign currency leading currency to depreciate, resulting imports to decline
and export to accelerate.

Objectives of Monetary Policy:

•Price stability

• Maintenance of full employment, and

• The economic prosperity and welfare of the people of the economy.

Price stability, that is controlled price level, is the imperative condition for
the constant economic growth, once accomplished leads to full employment
and economic prosperity. Price stability develops investor’s confidence –
boosting investments, causing acceleration of economic activity and
achievement of full employment.

Thus, the significance of monetary policy is to achieve the inflation target

(set by the central bank for required economic growth), and as a
consequence, to accelerate strong and sustainable economic growth.
Achievement of inflation target directs strong currency valuation in terms of
other foreign currencies, resulting as favorable balance of payments.
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.

• Open Market Operations: The most effective and major tool the central
bank uses to affect the monetary supply in the economy is open market
operations – that is, the buying and selling of government securities (usually
bonds or T-bills) by the central bank.

If the central bank decides to increase monetary base in the economy it

buys securities from the open market and pays for these securities by
crediting the reserve amounts of banks involved in selling. This will increase
the reserve amount the banks hold, such that banks have more money to
lend, interest rates my fall, leading to increase investment spending and as
a result economic growth.

Conversely, in order to tighten the monetary base in the economy, the

central bank sell the government securities, as a result collect payments
from banks by reducing their reserve accounts. Having less money in these
reserve accounts the opportunity cost of lending money decline, such that
interest rates may increase, resulting a drop of investment spending, that is
– the slowdown of economic activity.

• The Discount Rate: the rate at which financial institutions may borrow
funds for short-term directly from the central bank.When the central bank
reduces the discount rate, financial institutions must pay to borrow from the
central bank; financial institutions become more willing to borrow, to make
more money available for lending to businesses and households at low
interest rates. This would initiate more consumption and investment
spending and generate economic activity in the economy. The reverse would
be the effect in case of increased discount rate.

• Reserve Requirements: the proportion of the total assets that banks must
hold in reserve with the central bank. Financial institutions only maintain a
small portion of their assets as cash available for immediate withdrawal; the
rest is invested in illiquid assets (like loans and mortgages). The monetary
policy can be implemented by altering the proportion of these required
reserves. Increasing the proportion of total assets to be held as liquid cash
increases the amount of money available to banks as loanable funds, thus
mean the broader monetary base in the economy, vice versa.

How does Monetary Policy affect the economy of a country?

After having discussed the objectives and tools of monetary policy, let us
now talk about how policy affects the economy:

Consumption, Saving and Investment:

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.). Moreover stimulating bank’s willingness
to lend more and investors to invest more, on the other side discourage
saving, resulting to increase spending and aggregate demand.

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.

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.

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.

Modern Monetary Policy

Modern central banking dates back to the aftermath of great depression of

the 1930s. Governments, led by the economic thinking of the great John
Maynard Keynes, realized that collapsing money supply and credit
availability greatly contributed to the savagery of this depression. This
realization that money supply affected economic activity led to active
government attempts to influence money supply through "monetary policy".
At this time, nations created central banks to establish "monetary authority".
This meant that rather than accepting whatever happened to money supply,
they would actively try to influence the amount of money available. This
would influence credit creation and the overall level of economic activity.

Modern monetary policy does not involve gold to a great extent. In 1968,
the United States rescinded its promise to pay in gold and effectively
removed itself from the "gold standard". Since then, it has been the job of
the Federal Reserve to control the amount of money and credit in the U.S.
economy. I doing this, it wants to maintain the purchasing power of the U.S.
dollar and its comparative worth to other currencies. This might sound easy,
but it is a complex task in an information age where huge amounts of money
travels in electronic signals in microseconds around the world.

The Effectiveness of Monetary Policy

Economists debate the relevant measures of money supply. "Narrow" money

supply or M1 is currency in circulation and the currency in easily accessed
chequing and savings accounts. "Broader" money supply measures such as
M2 and M3 include term deposits and even money market mutual funds.
Economists debate the finer points of the implementation and effectiveness
of monetary policy but one thing is obvious. At the extremes, monetary
policy is a potent force. In countries such as the Russian Republic, Poland or
Brazil where the printing presses run full tilt to pay for government
operations, money supply is expanding rapidly and the currency becomes
rapidly worthless compared to goods and services it can buy. Very high
levels of inflation or "hyperinflation" is the result. With 30-40% monthly
inflation rates, citizens buy hard goods as soon as they receive payment in
the currency and those on fixed income have their investments rendered
worthless.

At the other extreme, restrictive monetary policy has shown its effectiveness
with considerable force. Germany, which experienced hyperinflation during
the Weimar Republic and never forgot, has maintained a very stable
monetary regime and resulting low levels of inflation. When Chairman Paul
Volcker of the U.S. Federal Reserve applied the monetary brakes during the
high inflation 1980s, the result was an economic downturn and a large drop
in inflation. The Bank of Canada, headed by John Crow, targeted 0-3%
inflation in the early 1990s and curtailed economic activity to such an extent
that Canada actually experienced negative inflation rates in several months
for the first time since the 1930s.
Without much debate, the effectiveness of monetary policy, its timing and its
eventual impacts on the economy are not obvious. That central banks
attempt influence the economy through monetary is a given. In any event,
insights into monetary policy are very important to the investor. The
availability of money and credit are key considerations in the pricing of an
investment.

Practical study of the Organization:

State Bank of Pakistan

INTRODUCTION TO THE ORGANIZATION

 Core Functions of State Bank of Pakistan

State Bank of Pakistan is the Central Bank of the

country. While its constitution, as originally laid
down in the State Bank of Pakistan Order 1948,
remained basically unchanged until 1st January
1974 when the Bank was nationalized, the scope
of its functions was considerably enlarged. The
State Bank of Pakistan Act 1956, with subsequent
amendments, forms the basis of its operations
today.

Like a Central Bank in any developing country, State Bank of

Pakistan performs both the traditional and
developmental functions to achieve macro-
economic goals. The traditional functions, which
are generally performed by central banks almost
all over the world, may be classified into two
groups: (a) the primary functions including issue
of notes, regulation and supervision of the
financial system, bankers’ bank, lender of the last
resort, banker to Government, and conduct of
monetary policy, and (b) the secondary functions
including the agency functions like management of
public debt, management of foreign exchange,
etc., and other functions like advising the
government on policy matters and maintaining
close relationships with international financial
institutions. The non-traditional or promotional
functions, performed by the State Bank include
development of financial framework,
institutionalization of savings and investment,
provision of training facilities to bankers, and
provision of credit to priority sectors. The State
Bank also has been playing an active part in the
process of islamization of the banking system. The
main functions and responsibilities of the State
Bank can be broadly categorized as under.
collection method

The mode of collection to be used when gathering information and data on a

given indicator of achievement or evaluation. Collection methods include the
review of records, surveys, interviews, or content analysis. The term is one
of the elements of the indicator methodology form for reporting through
IMDIS.

I used personal interviews technique for the collection of data

Interviews

Interviewing is a technique that is primarily used to gain an understanding of

the underlying reasons and motivations for people’s attitudes, preferences or
behavior. Interviews can be undertaken on a personal one-to-one basis or in
a group. They can be conducted at work, at home, in the street or in a
shopping centre, or some other agreed location.
STATE BANK OF PAKISTAN
MONETARY POLICY DECISION
27th March 2010

• Building on initial gains in macroeconomic stability the economy is

looking to further its traction for sustainable recovery. Inflationary
pressures have dampened but continue to persist, mainly due to
alignment of energy sector prices with market factors. Large Scale
Manufacturing (LSM) has consistently grown since October 2009 after
contraction for almost 20 months but remains fragile. Reduction in the
external current account deficit has allowed SBP to rebuild foreign
exchange reserves, despite shortfalls in external financial flows.
However, uncertainty has increased in some areas, particularly the
fiscal sector, with implications for the rest of the economy, including
monetary policy.
• Although CPI inflation (YoY) has come down to 13.0 percent in
February 2010, it is high and exhibits persistence. After a low of 8.9
percent in October 2009, inflation slipped back largely due to increases
in electricity tariffs, adjustments in the prices of domestic petroleum
products, and administered prices of commodities like wheat. To which
extent these factors will influence other prices in the economy and
expectations of inflation in the coming months remain difficult to
assess. Nonetheless, SBP expects the average CPI inflation for FY10 to
remain close to 12 percent.
• Despite presence of high inflation, crippling electricity shortages, and
challenging security conditions, domestic economic activity has picked
up in recent months. A cumulative growth of 2.4 percent during the
first seven months of FY10 in the Large Scale Manufacturing (LSM) is
encouraging. Sustainability of this trend in LSM and overall economic
growth would depend on improvements in the availability of electricity
and security situation. In addition, this would need supportive growth
in private sector credit, which in turn depends on a reduction in the
scale of government and public sector’s reliance on bank borrowings.
 • The balance of payments position has improved considerably. The
external current account deficit has come down to $2.6 billion during
July – February, FY10 compared to $8 billion in the same period last
year. This has allowed SBP to accumulate foreign exchange reserves,
$11.1 billion as on 26th March 2010, and has facilitated stability in the
foreign exchange market. However, other developments in the
external sector, such as Foreign Direct Investments (FDI) and workers’
remittances, need to be monitored closely, especially when prospects
of foreign official flows remain unclear.
• The key source of uncertainty, however, lies in the weak fiscal
position. Burdened by significant security related expenditures and
shortfalls in revenues, keeping the fiscal deficit for FY10 within target
would be challenging. Partial phasing out of subsidies and reduction in
development expenditures have helped in containing expenditures but
has lead to surge in domestic prices and is hurting crucial public sector
investment. Similarly, increased Petroleum Development Levy (PDL)
receipts, due to higher oil imports, have cushioned the lower tax
revenues to some extent but have contributed towards inertia in
domestic inflation. During the remaining months of FY10, uncertainty
regarding non-tax revenues on
account of foreign reimbursements and extent of remaining power sector
subsidies adds to fiscal complications.

• The financing mix of the fiscal deficit also seems uncertain. The
external financing for budget, especially the part pledged by the
Friends of Democratic Pakistan (FoDP), has mostly been elusive. Of
the Rs110 billion net external budget financing received during H1-
FY10, Rs93 billion were provided by the IMF. With an understanding
that this part of IMF money, provided in lieu of FoDP flows, is for short
term, the importance of the timing of external budgetary flows cannot
be overemphasized. Not surprisingly, therefore, government borrowing
from the SBP has been substantial in Q3-FY10. According to
provisional figures the outstanding stock of government borrowing
from SBP (on cash basis), as on 25th March 2010, stands at Rs1240
billion, which is Rs110 billion higher than the quarterly ceiling limit.

• With less than expected retirement of credit availed by the

government for commodity operations and commencement of the
2010 wheat procurement season, pressure will build on the banking
system resources. Continued borrowings by the Public Sector
Enterprises (PSEs), partly because of the lingering energy sector
circular debt, are also straining systemic liquidity. Further, the high
infection ratio of credit to Small and Medium Enterprises (SMEs) at 22
percent and Agriculture at 17 percent may lead banks to show
 reluctance to extend credit to the private sector even when the pace of
growth of incremental Non-performing Loans (NPLs) has slowed
considerably in the last quarter of 2009.

• In this environment, with resources tied up in both commodity and

circular debt and risk averse behaviour, banks will tend to negotiate
higher rates on risk-free or government guaranteed debt. For instance,
the first issuance of the Term Finance Certificate (TFC) in March 2009
was priced at KIBOR plus 1.75 percent, while the second issuance in
September 2009 was at KIBOR plus 2 percent. Similarly, the rates for
financing commodity operations were around KIBOR plus 2.5 to 2.75
percent. This reflects that banks are building in the cost of ongoing
rollover, instead of repayment, of outstanding credit. Thus, the
attractively priced government borrowing may lead to stagnation in
private sector credit growth.

• Government will have to revisit its commodity intervention strategy,

sooner than later, so that commodity operation requirements may go
back to normal levels. Similarly, a complete resolution of the circular
debt would be essential. Apart from releasing banking system
resources and easing pressure on market rates, it will alleviate some
constraints impeding production of electricity in the country thus
paving way for sustainable economic recovery.

• Given the uncertainties pertaining to the fiscal and quasi-fiscal sectors,

present stance of monetary policy is striking a difficult balance
between reducing inflation, ensuring financial stability, and supporting
economic recovery. An upward adjustment in SBP’s policy rate, at this
juncture, runs the risk of impeding the still nascent recovery, while a
downward adjustment runs the risk of fuelling an already high
inflation. Hence, SBP has decided to keep the policy rate unchanged at
12.5 percent.
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.

References

http://www.finpipe.com/monpol.htm
http://www.cnb.cz/en/monetary_policy/instruments/
http://www.defence.pk/forums/economy-development/13561-monetary-policy.html
http://www.ehow.com/about_5245679_objectives-monetary-policy.html

Economics
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