‘Impact of Monetary Policy on Economic Growth of Pakistan’

Name: Khizer Rizwan

Student ID: 17687

Objectives of Monetary Policy:

In any country monetary policy is used as an instrument through which the government achieves the goals
and objectives for economic growth and stability. In Pakistan monetary policy is the role of State Bank of
Pakistan. Money supply (M2=currency + demand deposits + time deposits) is an important target variable
of monetary policy in Pakistan. The target growth rate of money supply is set through estimated money
demand.

From recent some years Monetary Policy of Pakistan has dual objectives which are stability in prices and
boosting economic growth. SBP mainly used monetary policy variables to attain desired goals. To control
the supply of money and inflation SBP may use contractionary or expansionary policy. Job creation (full
employment) and eradication of poverty are also crucial objectives of monetary policy.

Monetary policy Management in Pakistan over the years:

State Bank of Pakistan has altered its administrative monetary policy towards a liberal and market
oriented policy management. The inflation rate of Pakistan for 2009 was expected to be 20% which was
40% higher than the last year 12%. On the other side growth rate of GDP for 2010 was estimated to be
4%. The monetary policy has to change to guide economy for the future.

SBP has designed contractionary policy to limit the inflation, increase in money and credit in economy.
At present, most of the countries have adopted contractionary policy to control inflation. On the other side
Expansionary monetary policy is used to increase the credit and broaden the monetary base by reducing
the interest rate.

Money supply instrument is used by SBP to obtain the main objective of monetary policy i.e. price
stability and economic growth. Moreover in order to hold inflation within the expected level State Bank
of Pakistan used money supply instrument. The statistics shows that growth in money supply has gone
above its targeted level from 2002 to 2005 due to Expansionary monetary policy.

In order to adjust money supply in accordance with the changes in exogenous variables, the State Bank of
Pakistan is supposed to use all instruments of monetary policy, i.e. reserve requirement, liquidity ratio,
discount rate, open market operation, credit control, and moral persuasion. Ronald Soligo (7) wrote an
article in 1967 on the monetary problems of Pakistan (1947-65) and concluded that "Monetary policies
that have been followed in Pakistan have been weak and ineffective in achieving the goals set by the
government. The main burden of maintaining price stability and promoting economic growth by
increasing saving and export rates has been borne by fiscal and exchange rates policies.

An effective monetary policy aimed at specific policy objectives has yet to be implemented". The purpose
of this paper is to review the monetary problems of Pakistan once again and evaluate the changes in
monetary policy that happened during the last twenty five years and determine the speed and direction of
these changes. To evaluate monetary policy this study discusses both already mentioned explicit and
implicit functions and for this purpose secondary data, some results from the AERC macro econometric
model, interviews with officials of the State Bank of Pakistan and with businessmen have been used.

Growth and monetary phenomenon:

Before 2005, monetary policy was mainly supporting the economic growth due to low inflation level but
from 2005 the inflation is going to rise. The monetary policy after 2005 concentrated on limiting the
inflation rate.

High rate of inflation not only influence economic performance but it also adversely affect the real
economic growth. There is relationship between inflation and economic growth. According to Smyth
(1992) 0.1% increase in inflation in USA it reduced the annual growth by 0.223%. If the rate of inflation
is high then it has significant negative effect on economic growth but at low rate of inflation the
relationship is negative but not significant. Inflation not only influences economic growth negatively but
it also increases economic uncertainty in the economy. Due to the harmful impacts of inflation most of the
world’s Central Banks have considered to stabilize the prices and make it the basic function of monetary
policy.