Central Bank and Monetary Policy

It is very difficult to suggest a precise definition of a central bank. However, a central

bank can best be defined with reference to its function. It can be defined as the bank which
stands as the leader of the money market-also called the financial market-issues notes and coins,
supervises, controls and regulates the activities of the banking system and act as the banker of
the government.

A central bank is a bank which constitutes the apex of the monetary and banking
structure. It managers the economy in the interest of general public welfare, but not
maximization of profit

According to W.A Shaw, the central bank is the bank which control credit.

“ Bank provides service to its clients and in turn receives perquisites in different forms.”--- P.A.
Samuelson

Origin of the Central bank

The establishment of a central bank in a modern economy is essential as it is apex

institution of a country’s financial as well as monetary system. Its action affects money supply,
the volume of credit, interest rate, etc. all these have direct impact not only on financial market
but also on national output and inflation (deflection). Thus the central bank plays an important
role in any economy.

In fact, every independent country must have a central bank for organizing, running, supervising,
regulating and developing the monetary-financial system of the country.

The first central bank was established in the 8 th century. Through the Riks Bank of Sweden was
set up in 1656 and the bank of the England in 1694, the bank of England started functioning in
1844. It is said that the bank of England is the oldest central bank of the world.
In America, Federal Reserve Banks started functioning as the central bank in 1913. The post-
World War II period witnessed a phenomenal growth of central banks all over the world. At
present, there are more than 150 central banks operating in various countries.

The State Bank of Pakistan

Evolution, Functions, & Organization

Introduction

The State Bank of Pakistan is the central bank of the country. Usually the starting point
for a central bank is a banking system that is already in place - the banking system necessitates
the presence of a central bank. But the State Bank of Pakistan (SBP) is unique in the sense that it
started its function in a newly born country, where it also had to shoulder responsibilities of
developing and rehabilitating a banking system and the economy, in addition to the traditional
central banking functions. Performance of the Bank since its inception in 1948, as reviewed in
subsequent pages, shows that it has faced all the challenges with a great zeal and commitment.
The founders of the Bank set a multi-dimensional target before it that included not only
regulation of the monetary and credit system but also the growth of this system. The vision of its
founders was a stable monetary system in Pakistan with fuller utilization of the country’s
productive resources (SBP Act, 1956).

In order to achieve the goals set before it, the State Bank of Pakistan performed all the
traditional and non-traditional functions. he traditional functions, which are generally performed
by central banks all over the world, are classified into two groups;

The primary functions. including issue of notes, regulation of the financial system,
lender of the last resort, and conduct of monetary policy.
 The secondary functions. Including management of public debt, management of
foreign exchange, advising the Government on policy matters, anchoring payments system, and
maintaining close relationships with international financial institutions. show in figure

Objectives of Central Bank

Through the monetary policy State Bank of Pakistan has following aims:

1. To establish as an institution for maximizing profits and to conduct overall economic activities.

2. To collect savings or idle money from the public at a lower rate of interests and lend these public
money at a higher rate of interests.
3. To create propensity of savings amongst the people.

4. To motivate people for investing money with a view to bringing solvency in them .

5. To create money against money as an alternative for enhancing supply of money.

6. To build up capital through savings.

7. To expedite investments.

8. To extend services to the customers.

9. To maintain economic stability by means of controlling money market.

10. To extend co-operation and advices to the Govt. on economic issues.

11. To assist the Govt. for trade& business and socio-economic development.

12. To issue and control notes and currency as a central bank.

13. To maintain and control exchange rates as a central bank.

Monetary policy

Monetary policy involves central banks’ use of instruments to influence interest rates and/or
money supply in the economy with the objective to keep overall prices and financial markets stable.
Monetary policy is essentially a stabilization or demand management policy that cannot impact long-term
growth potential of an economy. Preamble to SBP Act, 1956 envisages monetary policy to secure
monetary stability and attain fuller utilization of economy’s productive resources. In SBP’s view, the best
way to achieve these objectives on a sustainable basis is to keep inflation low and stable.

Low and stable inflation provides favorable conditions for sustainable growth and employment
generation over time. It reduces uncertainties about future prices of goods and services and helps
households and businesses to make economically important decisions such as consumption, savings and
investments with more confidence. This, in turn, facilitates higher growth and creates employment
opportunities over the medium term leading to overall economic well-being in the country.
 In practice, SBP’s monetary policy strives to strike a balance among multiple and often competing
considerations. These include: controlling inflation, ensuring payment system and financial stability,
preserving foreign exchange reserves, and supporting private investment.

There are two method to control the money of supply through monetary policy:

1. Quantitative monetary policy

2. Qualitative monetary policy