monetary policy

Group Members

SagarSaba Saleem

AbidullahSana Azmat

Saira BibiSyed Taimur Ashfaq

Muhammad Faheem Akhtar

Central Bank, Monetary policy objective and interest rate

SAGAR

Central Bank

A central bank is basically national bank which provides financial and banking services for its country’s government and commercial banking system, as well as implementing the government’s monetary policy and issuing currency.

Pakistan central Banks is state Bank of Pakistan(SBP) which established in May 1948. After the independence of Pakistan.

Example of USA Central Bank

What is money

A medium of exchange Anything generally accepted as a method of payments (coins, paper currency, deposits in banks accounts)

Type of Money

M1 MoneyA measure of the money supply that includes all physical money, such as coins and currency, as well as demand deposits, checking accounts.

M2 MoneyA measure of money supply that includes (M1) as well as near money. “Near money" in M2 includes savings deposits, money market mutual funds and other time deposits, which are less liquid and not as suitable as exchange mediums but can be quickly converted into cash or checking deposits.

Current Money Supply In Pakistan

According to State Bank of Pakistan Current Money Supply in Pakistan is 9,854,065 PKR Million in October of 2014Average Money Supply in Pakistan from 2008 to 2014 is 6,779,476.34 PKR Million

SABA SALEEM

Monetary Policy

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability

Targets of Monetary Policy

Open Market Operation

Discount Rate

Reserve Requirement

Money Supply

Interest Rate

Reserves

Growth Rate

Stable Inflation

Low Unemployment

Quantitative Tools of Monetary Policy

1- Bank Rate Policy or Discount Rate

The setting of interest rate at which commercial banks and other depositary institutions can borrow reserves from central bank. When the central bank finds that inflationary pressures have started emerging within the economy, it raises the bank rate. Borrowing from the central bank becomes costly and commercial banks borrow less from it.The commercial banks, in turn, raise their lending rates to the business community and borrowers borrow less from the commercial banks. There is contraction of credit and prices are checked from rising further. On the contrary, when prices are depressed, the central bank lowers the bank rate.It is cheap to borrow from the central bank on the part of commercial banks. The latter also lower their lending rates. Businessmen are encouraged to borrow more. Investment is encouraged. Output, employment, income and demand start rising and the downward movement of prices is checked.

2- Open Market Operations

Open market operations refer to sale and purchase of securities in the money market by the central bank. When prices are rising and there is need to control them, the central bank sells securities. The reserves of commercial banks are reduced and they are not in a position to lend more to the business community.


3- Reserve Ratios

Every bank is required by law to keep a certain percentage of its total deposits in the form of a reserve fund in its vaults and also a certain percentage with the central bank.When prices are rising, the central bank raises the reserve ratio. Banks are required to keep more with the central bank. Their reserves are reduced and they lend less. The volume of investment, output and employment are adversely affected. In the opposite case, when the reserve ratio is lowered, the reserves of commercial banks are raised. They lend more and the economic activity is favorably affected.


ABIDULLAH

Qualitative Tools of Monetary Policy

1- Moral Suasion

It is concerned with just as moral request by central bank to commercial banks, that loans should not be given for unproductive fields which create inflation. Loans should not be given for speculation and hoarding. The commercial banks obey the order of central bank because central bank is the chief of money market and last resort.

2- Consumer Credit Control

Consumer credit accelerates inflation. Accordingly central bank issues instructions to commercial banks that they should not advance loans for consumption purposes. During deflation central bank allow the commercial banks to advance more loans for consumption purposes. So that deflation can be removed.


3- Direct Action

If central bank finds that commercial banks are not obeying its instructions and are advancing more loans for unproductive purposes, i-e speculation, hoarding and black marketing which will create inflation, or it is advancing loans for other than agriculture sector. Then central bank takes direct action. It refuses to re-discount the bills of exchange offered by commercial banks.


4- Publicity

Central bank in its research department collects data regarding the performance of the economy and commercial banks. If central bank finds that commercial banks are advancing loans for unproductive purposes. Then central bank publishes that commercial bank with bad name so each commercial bank avoids itself.


SANA AZMAT

Objective of Monetary Policy Countrywide

The objectives of monetary policy differ from country to country according to their economic conditions.

In the less developing countries like India or Pakistan its objective may be the maintenance of monetary stability and help in the process of economic development.

In the developed countries its objective may be to achieve full employment, without inflation.

Main Objective of Monetary Policy

1- Control of Inflation and Deflation

Inflation and deflation both are not suitable for the economy. If the price level is reasonable and there is an adjustment between the price and cost, rate of out put can increase. Monetary policy is used to coordinate the cost and price. So price stability is achieved through the monetary policy.

2- Exchange Stability

Monetary policy second objective is to achieve the stable foreign exchange rate. If the rate of exchange is stable it shows that economic condition of the country is stable.


3- Economic Development

Monetary policy plays very effective role in promoting economic growth by providing adequate credit to productive sectors.

4- Increase in the Rate of Employment

Monetary policy another objective is to achieve full employment but without inflation


5- Equal Distribution of Credit

Monetary policy should also ensure that distribution of credit should be equitable and purposeful. The credit priority should be given to backward areas.

6- Improvement in Standard of Living It is also the major objective of the monetary policy that it should improve the quality of life in the country.


SAIRA BIBI

What is interest rate

The cost of using borrowing money is called interest money.

If borrowed money is 100$ and interest rate is 10% then we paid at the time of payment 110$ in which 10$ is the cost of using 100$.

Current interest rate in Pakistan is 9.5%.

Type of Interest Rate

Simple Interest The most easy and simple to use because it ignores the effects of compounding. It is the product of principal amount, the rate and the time period of amount borrowed for.

Simple Interest = Principle * Rate * Time period

Compound Interest

Unlike simple interest the principle changes with every time period. The new principal at the end of every time period is essentially the simple interest on the principal at the beginning of the time period, added to the principal.


Real InterestThe interest rate that has been adjusted to remove the effect of inflation to reflect real cost of fund to the borrower, and the real yield to the lender. Real interest= nominal interest –inflationIn 2012,The real interest rate is 3.26%,compared to -3.29% last year.this is higher then long term average of 0.01%

Nominal InterestThe interest rate unadjusted for inflation. It includes all the three risk factors, plus the time value for money.


History of Interest Rate in Pakistan

Pakistan Money Last Previous Highest Lowest UnitInterest Rate 9.50 10.00 20.00 7.50 percent [+]

Interbank Rate 9.95 9.98 17.42 1.21 percent [+]

Money Supply M0

2886363.62 2772985.00 2985235.07 1413617.11 PKR Million [+]

Money Supply M1

7741709.00 7674386.00 7741709.00 3168848.00 PKR Million [+]

Money Supply M2

9853065.00 9797427.00 9853065.00 4431502.00 PKR Million [+]

Money Supply M3

12586019.37 12513731.00 12586019.37 5548454.00 PKR Million [+]

Foreign Exchange Reserves

13442.90 13511.30 18294.80 1973.60 USD Million [+]

http://www.tradingeconomics.com/pakistan/interest-rate

http://www.tradingeconomics.com/pakistan/interest-rate

http://www.tradingeconomics.com/pakistan/interbank-rate

http://www.tradingeconomics.com/pakistan/interbank-rate

http://www.tradingeconomics.com/pakistan/money-supply-m0












http://www.tradingeconomics.com/pakistan/foreign-exchange-reserves



SYED TAIMUR ASHFAQ

Effect of Money Supply on Interest rate

The money supply has a direct effect on nominal interest rates in an economy.

When the money supply increases, the supply curve shifts to the right and the nominal interest rate decreases.

When it decreases, the supply curve shifts left and nominal interest rates increase. Thus, for easy money actions, the increases in the money supply cause interest rates to decrease.

With lower nominal interest rates, loans become less costly. Businesses then use these lower interest rates to invest and expand, causing economic growth. For tight money actions, the money supply decreases causing interest rates to increase.

Higher nominal interest rates cause loans to become more expensive, consequently causing businesses to expand less. This creates a slowdown in the economy. The effects can be seen on the graphs below.

The demand for money has also direct effect on nominal interest rates in an economy.

When the demand for money increase, the demand curve shifts to the right and the nominal interest rate increase.

When it decreases, the demand curve shifts left and nominal interest rates decrease. Thus, for easy money actions, the increases in the money demand cause interest rates to increase.

With lower nominal interest rates, loans become less costly. Businesses then use these lower interest rates to invest and expand, causing economic growth. For tight money actions, the money supply decreases causing interest rates to increase.

Higher nominal interest rates cause loans to become more expensive, consequently causing businesses to expand less. This creates a slowdown in the economy. The effects can be seen on the graphs below.

Effect of Demand of Money on Interest rate

Effect of Demand of Money on Interest rate

Effect of Interest Rate in Pakistan

Increase of Interest RateWhen the Interest rate of Pakistan

economy increased people will save more money in banks and people will not do investment, due to low investment the economy of Pakistan grow slow, with slow economy of Pakistan the inflation slow and the aggregate demand falls in return the Gross Domestic Product will fall.

Decrease of Interest Ratewhen the interest rate of Pakistan economy

decreased people will borrow more money from bank due to low interest rate, people will not save their money in banks, they will do investment in country, due to investment the economy of Pakistan grow, the inflation increase, the output increase and finally the Gross Domestic Product will Increase

MUHAMMAD FAHEEM AKHTAR

RECOMMENDATION AND SOLOUTION

• The State Bank of Pakistan need to formalize their policy regarding about the commercial bank.

• For effective analysis of developments and policy making, timely and quality information is extremely important, it should be maintain.

• The data collection in Pakistan relating about GDP is very poor it should be improved by government policies.

• Moreover, the data on key macroeconomic variables (such as government expenditure and revenue, output of large-scale manufacturing, crop estimates, is usually available with substantial lags. This constrains an in-depth analysis of the current economic situation and evolving trends, and hinders the ability of the SBP to develop a forward-looking policy stance.

• Unlike many countries, both developed and developing, there is no prescribed limit on government borrowing from SBP defined in the SBP Act or the Fiscal Responsibility and Debt Limitation (FRDL) Act 2005. Besides being highly inflationary, government borrowing from SBP also complicates liquidity management.


• Another issue is to make a clear distinction between exchange rate management and monetary management. Currently, there is a general perception that the State Bank is bound to keep the exchange rate at some predefined level and any movement away from this level is then considered as an inefficiency of the SBP

• There is a need to understand that for an open economy, it is impossible to pursue an independent monetary and exchange rate policy as well as allowing capital to move freely across the border. Since the SBP endeavors to achieve price stability through achieving monetary targets by changes in the policy rate, It is not possible to maintain exchange rates at some level with free capital mobility.

• Re-regulation of financial markets is a requirement to reduce herd behavior and eliminate the problems associated with too-big-to-fail institutions;

• Developing countries should use capital controls, foreign reserve accumulation and foreign exchange management to reduce the risk of financial crises;

• Adjustment of real wages in line with productivity to promote domestic consumption is necessary for a sustainable recovery in developed countries;

• Monetary policy could then reduce its focus on price stability and pay greater attention to securing low-cost finance for investment in real productive capacity.


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monetary policy