MONETARY POLICY

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onetary policy is the process by which the government, central bank, or monetary authority manages the money supply to achieve specific goals— such as constraining inflation or deflation, maintaining an exchange rate, achieving full employment or economic growth. (Usually the goal of monetary policy is to accommodate economic growth in an environment of stable prices.) Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, acting as a last-resort lender (i.e. discount window lending), or trading in foreign exchange markets. Monetary policy is generally referred to as either being an expansionary policy, or a contractionary policy, where an expansionary policy increases the total supply of money in the economy, and a contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation.

AN OVERVIEW
Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, and the total supply of money. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Where currency is under a monopoly of issuance, or where there is a regulated system of issuing currency through banks which are tied to a central bank, the monetary authority has the ability to alter the money supply and thus influence the interest rate (in order to achieve policy goals). The beginning of monetary policy as such comes from the late 19th century, where it was used to maintain the gold standard. A policy is referred to as contractionary if it reduces the size of the money supply or raises the interest rate. An expansionary policy increases the size of the money supply, or decreases the interest rate. Further monetary policies are described as accommodative if the interest rate set by the central monetary authority is intended to spur economic growth, neutral if it is intended to neither spur growth or combat inflation, or tight if intended to reduce inflation. There are several monetary policy tools available to achieve these ends. Increasing interest rates, reducing the monetary base or increasing reserve requirements all have the effect of contracting the money supply, and, if reversed, expand the money supply. Since the 1970s, monetary policy has generally been formed separately from fiscal policy. And 1

even prior to the 1970s, the Bretton Woods system still ensured that most nations would form the two policies separately. Within almost all modern nations, special institutions (such as the Bank of England, the European Central Bank or the Federal Reserve System in the United States) exist which have the task of executing the monetary policy independently of the executive. In general, these institutions are called central banks and often have other responsibilities such as supervising the smooth operation of the financial system. The primary tool of monetary policy is open market operations. This entails managing the quantity of money in circulation through the buying and selling of various credit instruments, foreign currencies or commodities. All of these purchases or sales result in more or less base currency entering or leaving market circulation.

INSTRUMENTS OF MONETARY POLICY
The techniques or instruments which are available to the authorities to achieve their targets for monetary policies include: a. Changing the level/and /or structure of interest rates through open market operations b. Government funding policy- i.e. the size of the public sector borrowing requirement or PSBR ( or the PSDR- public sector debt repayment) and the method of funding it c. Reserve requirements d. Direct controls, which might be either: - Quantitative - Qualitative e. Interventions to influence the exchange rate

CONTROL OVER THE LEVEL AND STRUCTURE OF INTEREST RATES
When the government uses interest rates as an instrument policy, it can try to influence either the general level of interest rates or the term structure of interest rates. It could do this by influencing either shot term interest rates or long term interest rates. Long term rates could possibly be influenced by increasing or reducing the PSBR, and so through the government’s funding policy and gilts issues. Influence over interest rates concentrates on short term “(money market) rates, through open market operations in the discount market. Open market operations can influence interest rates in the discount market, with an immediate ‘knock-on’ effect into other money markets, particularly the inter bank market. As we have seen, interest rates in the inter-bank market influence commercial banks base rates and lending rates.

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It is reasonable to conclude that if influence over short term interest rates is used as a monetary policy technique, its ultimate aim should be to control inflation or the exchange rate rather than to control broad money supply growth.

RESERVE REQUIREMENTS ON BANKS AS A MEAN OF CONTROLLING THE MONEY SUPPLY
As another technique for controlling money supply growth, the government might impose reserve requirements on banks. A reserve requirement might be a compulsory minimum cash reserve (i.e. ratio of cash to total assets) or a minimum liquid asset ratio. Any initial increase in bank deposits or building society deposits will result in a much greater eventual increase in deposits, because of the credit multiplier: Ignoring leakages, the formula for the credit multiplier is: D = C/r Where C is the initial increase in deposits r is the liquid assets ratio or reserve assets ratio D is the eventual total increase in deposits

If the authorities wished to control the rate of interest in bank lending and building society lending, they could impose minimum reserve requirements- i.e. a minimum value for r. the bigger the value of r, the lower the size of the credit multiplier would be. There are drawbacks to reserve requirements as a monetary policy instrument: a) Unless the same requirements apply to all financial institutions in the country, some institutions will simply take business from other. For example, reserve requirements on UK banks but not on building societies would give the building societies a competitive advantage over the banks, without having any effect on the control of total credit/money supply growth. b) Similarly, restrictions on domestic financial institutions which do not apply to foreign banks would put the domestic financial institutions at a competitive disadvantage in international markets. This is one reason why international cooperation on the capital adequacy of banks is an important step towards better regulation of financial markets.

DIRECT CONTROLS AS A TECHNIQUE OF MONETARY CONTROL

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Another way of controlling the growth of the money supply is to impose direct controls on bank lending. Direct controls may be either quantitative or qualitative: a) Quantitative controls might be imposed on either bank lending (assets), for example a ‘lending ceiling’ limiting growth, or bank deposits (liabilities). The purpose of quantitative controls might be seen as a means of keeping bank lending in check without having to resort to higher interest rates. b) Qualitative controls might be used to alter the type of lending by banks. For example, the government (via the Central Bank) can ask the banks to limit their lending to the personal sector, and lend more to industry, or to lend less to a particular type of firm (such as, for example, property companies) and more to manufacturing businesses. Controls might be temporary, in which case, in time, interest rates would still tend to rise if the money supply growth is to be kept under control. However, the advantage of a temporary scheme of direct quantitative controls is that it gives the authorities time to implement longer term policy. Quantitative controls are therefore a way of bridging the time-lag before these other policies take effect. Quantitative controls might be more permanents. If they are, they will probably be unsuccessful because there will be financial institutions that manage to escape the control regulations, and so thrive at the expense of controlled institutions. Direct controls in banks, for example, might succeed in reducing bank deposits but they will not succeed in controlling the level of demand and expenditure in the economy if lending is redirected into other non-controlled financial instruments of non-controlled financial institutions. For example, large companies might use their own bank deposits to set up a scheme of lending themselves. Direct controls are therefore rarely effective in dealing with the source rather than the symptom of the problem. Direct controls tend to divert financial flows into other, often less efficient, channels, rather than to stop the financial flows altogether, i.e. ‘leakages’ are inevitable.

QUALITATIVE CONTROLS AND PRUDENTIAL CONTROLS
Qualitative controls might be mandatory or they might be applied through ‘moral suasion’. Mandatory directives of a qualitative nature are unlikely in practice, because they are difficult to enforce without the co-operation of banks and other financial institution. Moral suasion, on the other hand, might be used frequently. This is a process whereby the authorities (Central Bank) appeal to the banks: a) To restrain lending

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b) To give priority to certain types of lending such as finance for exports or for investment c) To say ‘no’ to other types of lending such as loans to private individuals

Moral suasion might therefore be a temporary form of control. Prudential control refers to the oversight of banks and other financial institutions by the authorities to ensure that they have an adequate capital structure, liquidity (asset portfolio) and/or foreign exchange exposure. A distinction can be made between: d) Enforceable qualitative controls such as the Central Bank might exert in its role as supervisor of the banking system. However, it is easier to enforce quantitative controls than qualitative ones since adherence to the rules can be measured e) Suggestions by the Central Bank about what other banks might wish to do

f) Requests by the Banks, giving an indication of what it would like other banks to do

EXCHANGE RATE CONTROL AS AN INSTRUMENT OF MONETARY POLICY
The exchange rate and changes in the exchange rate have implications for the balance of payments, inflation and economic growth. The government might therefore seek to achieve a target exchange rate for its currency.

TYPES OF MONETARY POLICY
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In practice all types of monetary policy involve modifying the amount of base currency (M0) in circulation. This process of changing the liquidity of base currency through the open sales and purchases of (government-issued) debt and credit instruments is called operations. Constant market transactions by the monetary authority modify the supply of currency and this impacts other market variables such as short term interest rates and the exchange rate. The distinction between the various types of monetary policy lies primarily with the set of instruments and target variables that are used by the monetary authority to achieve their goals.

Monetary Policy:

Target Market Variable: Long Term Objective: Interest rate on overnight Inflation Targeting A given rate of change in the CPI debt Interest rate on overnight Price Level Targeting A specific CPI number debt The growth in money Monetary Aggregates A given rate of change in the CPI supply The spot price of the Fixed Exchange Rate The spot price of the currency currency Low inflation as measured by the Gold Standard The spot price of gold gold price Mixed Policy Usually interest rates Usually unemployment + CPI change

The different types of policy are also called monetary regimes, in parallel to exchange rate regimes. A fixed exchange rate is also an exchange rate regime; The Gold standard results in a relatively fixed regime towards the currency of other countries on the gold standard and a floating regime towards those that are not. Targeting inflation, the price level or other monetary aggregates implies floating exchange rate unless the management of the relevant foreign currencies is tracking the exact same variables (such as a harmonized consumer price index).

a. INFLATION TARGETING

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B.

PRICE LEVEL TARGETING

c.

MONETARY AGGREGATES

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In the 1980s several countries used an approach based on a constant growth in the money supply. This approach was refined to include different classes of money and credit (M0, M1 etc). In the USA this approach to monetary policy was discontinued with the selection of Alan Greenspan as Fed Chairman. This approach is also sometimes called monetarism. Whilst most monetary policy focuses on a price signal of one form or another this approach is focused on monetary quantities.
D.

FIXED EXCHANGE RATE

Under a system of fiat fixed rates, the local government or monetary authority declares a fixed exchange rate but does not actively buy or sell currency to maintain the rate. Instead, the rate is enforced by non-convertibility measures (e.g. capital controls, import/export licenses, etc.). In this case there is a black market exchange rate where the currency trades at its market/unofficial rate. Under a system of fixed exchange rates maintained by a currency board every unit of local currency must be backed by a unit of foreign currency (correcting for the exchange rate). This ensures that the local monetary base does not inflate without being backed by hard currency and eliminates any worries about a run on the local currency by those wishing to convert the local currency to the hard (anchor) currency.

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MIXED POLICY
In practice a mixed policy approach is most like "inflation targeting". However some consideration is also given to other goals such as economic growth, unemployment and asset bubbles.

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CHANNELS OF MONETARY TRANSMISSION
• • • • Bank Lending Channel Exchange Rate Channel Asset Price Channel Direct Interest Rate Channel

Bank Lending Channel
We first examine the role of bank credit. Under a contractionary monetary policy shock ‘bank lending channel’ operates through the fall in bank reserves, implying a reduction in the supply of loanable funds by the banks. In other words, monetary policy may have amplified effects on aggregate demand by modifying the availability or the terms of new loans. The lending channel presumes that small and medium-sized firms, facing informational frictions in financial markets, rely primarily on bank loans for external finance because it is not possible for these borrowers to issue securities in the open market. The importance of this channel thus depends on three factors: (ii) (iii) (i) the degree to which the central bank has allowed banks to extend loans; monetary policy stance; and The dependence of borrowers on bank loans. These factors are clearly influenced by the structure of the financial system and its regulation. The bank lending channel is an enhancement mechanism to the interest rate channel. The key point here is that the real effects of higher interest rates may be amplified through the lending channel, beyond what would be predicted were policy transmitted only through the traditional interest rate channel (cost of capital). As market interest rates rise subsequent to monetary tightening, business investment falls not only because cost of capital is high but also due to supply of bank loans mostly to small and medium sized firms is reduced. Looking forward, the importance of credit channel will further improve mainly because of financial sector reforms and continued expansion of private sector credit. On the contrary, reliance on bank finance should decline as capital markets become more developed. Nevertheless, given the fact that capital market development tends to take place gradually and the increased emphasis on small and medium scale enterprises in Pakistan, the overall effect in the medium term should be an increase in the significance of the bank-lending channel.

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Exchange Rate Channel
The strength of the exchange rate channel depends on the responsiveness of the exchange rate to monetary shocks, the degree of openness of the economy, and the sensitivity of net exports to exchange rate variations. In a small open economy, a nominal depreciation brought on by monetary easing, combined with sticky prices, results in a depreciation of the real exchange rate in the short-run and thus higher net exports.

Asset Price Channel
The role asset prices may play in the transmission mechanism of monetary policy is well known theoretically, although quite difficult to characterize empirically. Monetary policy shocks results into fluctuations in assets prices. A monetary policy easing can boost equity prices in two ways: (i) (ii) By making equity relatively more attractive to bonds (since interest rate fall) and By improvement in the earnings outlook for firms as a result of more spending by households.

Higher equity prices have dual impact of monetary impulses. First, higher equity prices increase the market value of firms relative to the replacement cost of capital, spurring investment; secondly, increase in stock prices translate into higher financial wealth of household and therefore higher consumption. In addition, to the extent that higher equity prices raises the net worth of firms and households which improves their access to funds, the effects captured would partly reflect the ‘broad credit channel’ of monetary policy as well. A broader range of assets, for example real estate – commercial and residential – may be included to cover the wealth effects; however, due to data limitations, we use stock market equity, keeping in mind that these may serve as a proxy to broader range of assets. Typically, peaks in equity prices tend to lead those in real estate prices. However, the relationship is somewhat less clear around troughs. These results need to be accepted with a caution as the share ownership is not yet very common in Pakistan, and firms mostly rely on bank credit for their financing needs as against equity financing. We anticipate the role of asset prices in the transmission mechanism to increase in the future as the capital market develops.

Direct Interest Rate Channel
The interest rate channel, also referred to as the traditional channel, is the primary mechanism at work in conventional macroeconomic models. Assuming some degree of

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price stickiness, an increase in nominal interest rates, for example, translates into an increase in the real rate of interest and the higher cost of capital. These changes in interest rates may lead to a postponement in consumption or a reduction in investment spending. In the absence of any good indicator for cost of capital, we have measure its impact indirectly.

MONETARY POLICY APPLIED BY STATE BANK
FY-08 has been troublesome for the Pakistani economy as it faced various challenges, whose repercussions continue to impact the FY-09.These include: a. b. c. d. e. Drain of liquidity from the financial system Rising global commodity, oil and staple food prices Depleting foreign reserves due to disinvestment by foreign investors Surge in import bill Devaluation of the Rupee

The unfolding events on both international and domestic front have enhanced the economic stress in Pakistan. Pakistan is likely to register a slowdown, and has witnessed exceptional rise in inflation, which is now emerging as the biggest challenge facing the economy. The Central bank is expected to play a key role in the current scenario to strike a balance between growth and price stability. On the balance it is being acknowledged that managing domestic demand pressures is critical in avoiding further and steeper rise of inflation; current rate of inflation has already started to impact economic growth and has induced fresh threats to economic stability. The excessive drain of rupee liquidity from the system is attributable to the net falling assets, strong credit demand and strong government borrowing from the SBP. Strong actions have been taken in order to infuse liquidity into the market: i. Liquidity injections through Open Market Operations (OMOs) ii. Increased allowance of commercial banks in T-Bill auctions

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Another growing concern for the economy was the growing external account deficit and the spiraling of the fiscal deficit out of sustainable levels. The external current account deficit for Pakistan has reached to $5.9 Billion. The export revenues were nominal compared to our import bills. The import of oil and food constitutes the major part of our import bill approximately 40% of the total bill. The oil import bill was $4.9 Billion alone.

Also, the exchange rate remained under pressure and the foreign exchange reserves depleted as investors due to rising political uncertainty and weakened economy. Keeping this in mind the SBP took the following corrective actions during the course of H1-FY09.
A.

INCREASED THE DISCOUNT RATE

Discount rate is the rate at which commercial banks obtain money from the central bank. Loans given to private businesses and individuals are priced on the basis of this rate. It has been increased from 13% in H2-FY08 by a 200 bps to 15% in H1-FY09. It is evident that the SBP has introduced a very tight monetary policy. This increase has been necessitated by the persistent and excessive government borrowing from SBP to meet the financing requirement of the budget deficit, the precarious and unsustainable balance of payment position, global financial crises and the high commodity prices. In order to offload this huge debt to the

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scheduled banks, this increase will act as a critical measure to induce scheduled banks to participate actively in T-bill auctions, which have been mostly unsuccessful in mobilizing receipts for the government in recent past. This will also help in pushing up the low and decline real lending rates necessary to curb the demand pressures and decelerate the current rapid rise in inflation. An increase in interest rates is necessary to encourage savings in the economy, importance of which cannot be over emphasized given the state of fiscal and external current account deficits.

b.

REDUCED THE

CRR

To ease the liquidity conditions, SBP reduced the Cash Reserve Requirement, in a staggered manner, by 400 bps to 5%. The SBP also exempted time deposits from the Statutory Liquidity Requirement and took a host of other measures. In the same vein, to meet the credit requirements of the exporters, the SBP decided to provide 100 percent refinancing to banks under the Export Finance Scheme (EFS). These measures allowed the SBP to address the liquidity situation while remaining vigilant in draining excessive liquidity build-ups. The decrease in the CRR is supposed to have an immediate impact on inter-bank interest rates by providing excess liquidity. The SBP in its policy has given utmost importance to a. Demand management – controlling aggregate demand to release demand oriented pressures from the economy. b. Controlling the rising external current account deficit c. Increasing the depleting foreign reserves. d. Controlling the escalating CPI inflation which results in decreased economin activity e. Curbing the liquidity shortages in the money market These measures are necessary for price stability and long term sustainable growth. Although it is estimated that demand pressures will recede during the current year if the supply side issues are not addressed these pressures would remain unchanged.

EFFECTS OF THE MONETARY POLICY
1. Investment will be reduced and saving will be encouraged. 2. Deposit mobilization. 3. Inflationary pressures on the economy are most likely to recede as demand growth will be substantially curtailed.

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4. Government borrowing is most likely to be reduced as per policy, to further tighten monetary conditions. Furthermore, as the SBP is less likely to allow the government to borrow excessively the government would have to look for alternative sources of funding and perhaps reduce their expenditures. 5. Investment in certain sectors is most likely to increase (e.g. Textile, other Exports) as SBP has extended incentives to them. 6. Reduction in the overall import bill and non- developmental expenditure due to no longer extending of subsidies on commodities.

ASSOCIATED RISKS

1. Inflationary pressures on the economy though expected to recede, if increased may grow out of control. 2. The current account deficit is due to high import bills. If local production does not increase this trend would continue and widen the fiscal deficit. 3. Foreign inflows in Pakistan are likely to be low as the local currency has been rated very low by international agencies. 4. Demand management is addressed by this monetary policy however if it continues to increase disproportionately it would put pressure on the economy and increase macro economic policies.

CONCLUSION
• The H1-FY09 Monetary policy goals are: Controlling inflation Stabilizing the exchange rate Reduce government borrowing Macroeconomic stability Controlling the external current account deficit and fiscal deficit Liquidating the money market Increase tax revenue

• A Contractionary Policy has been implemented by the Central Bank to increase the total money supply. • Some of the factors involved in failure of market-based monetary policy are:

- SBP has failed to regulate commodity financing operations. 15

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Net foreign reserves - decline Net long term foreign capital inflows- declined. Worsening external debt situation SBP’s ineffectiveness to recover banks debts. Concentration of financial sector assets. Key challenges to monetary policy, faced by SBP are: Growing external current account deficit. Inflation Excessive government borrowings Pressures on Forex reserve

CRITICISM ON THE MONETARY POLICY
The H1-FY09 monetary policy has met great criticism from economists, bankers and business men. According to the Federation of Pakistan Chambers of Commerce and Industry President Sultan Ahmed Chawla, the high interest rate would further push up the cost of production, which would definitely be transferred to consumers, adding to inflationary pressures rather than curbing inflation. This inflation is not demand-push, which can be controlled through a tight monetary policy. Instead, the major causes of rising inflation in the country are the hike in prices of oil, wheat and other food items. All these are inelastic products and the monetary policy cannot control their prices. Measures must be taken to improve the supply of these goods and improve our supply management. Economists have been arguing for an expansionary policy in this state of recession to control over the damaging effects on employment and investment. Businessmen and Industrialists have been extremely critical and opposed to the new monetary policy and have expressed concerns over the closure of industry owing to high mark up and the continued negligence of the business community. They argue that this step would further increase the cost of production and destroy the industries. President of the Karachi Chamber of Commerce and Industry, Anjum Nisar was of the opinion that Pakistan was fast on its way of becoming one of the most expensive countires of the world. Furthermore, the Central Bank maintained the discount rate to induce commercial banks to participate in T-Bill auctions. However, the hike in State Bank’s discount rate failed to induce banks into investment in treasury bills as banks chose to invest only in threemonth papers taking no interest in six-month bills and showing little inclination to invest in one-year papers. 16

UNITED STATES MONETARY POLICY
The object of monetary policy is to influence the performance of the economy as reflected in such factors as inflation, economic output, and employment. It works by affecting demand across the economy—that is, people's and firms' willingness to spend on goods and services.

MONETARY POLICY TOOLS
MONETARY BASE
Monetary policy can be implemented by changing the size of the monetary base. This directly changes the total amount of money circulating in the economy. A central bank can use open market operations to change the monetary base. The central bank would buy/sell bonds in exchange for hard currency. When the central bank disburses/collects this hard currency payment, it alters the amount of currency in the economy, thus altering the monetary base. Open market operations play an important role in:
• • •

Steering interest rates Managing the liquidity situation in the market Signalling the stance of monetary policy

Key figures for outstanding open market operations

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Related to monetary policy implementation issued by the ECB in 2009 :

RESERVE REQUIREMENT
The monetary authority exerts regulatory control over banks. Monetary policy can be implemented by changing the proportion of total assets that banks must hold in reserve with the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. By changing the proportion of total assets to be held as liquid cash, the Federal Reserve changes the availability of loanable funds. This acts as a change in the money supply.

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The low-reserve tranche amount and exemption amount effective on January 1, 2009 are 44.4 and 10.3 (in millions on U.S dollars) .

DISCOUNT WINDOW LENDING
Many central banks or finance ministries have the authority to lend funds to financial institutions within their country. By calling in existing loans or extending new loans, the monetary authority can directly change the size of the money supply.

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Interest rates
The contraction of the monetary supply can be achieved indirectly by increasing the nominal interest rates. Monetary authorities in different nations have differing levels of control of economy-wide interest rates. In the United States, the Federal Reserve can set the discount rate, as well as achieve the desired Federal funds rate by open market operations. This rate has significant effect on other market interest rates, but there is no perfect relationship. In the United States open market operations are a relatively small part of the total volume in the bond market. One cannot set independent targets for both the monetary base and the interest rate because they are both modified by a single tool — open market operations; one must choose which one to control. In other nations, the monetary authority may be able to mandate specific interest rates on loans, savings accounts or other financial assets. By raising the interest rate(s) under its control, a monetary authority can contract the money supply, because higher interest rates encourage savings and discourage borrowing. Both of these effects reduce the size of the money supply. Fed Funds Interest Rate

Past Trend Present Value & Future Projection

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THE BAILOUT PLAN
In September 2008, the Bush administration proposed and negotiated a $700 Billion Bailout Plan with the Congressional politicians. The US Treasury Secretary, Henry M. Paulson proposed for a sweeping bailout of financial institutions. He asked Congress for $700 billion to use to buy up mortage-backed securities whose value had dropped sharply or had become impossible to sell, in what he called the Troubled Asset Rescue Plan As originally outlined, the government would have bought up toxic mortgage-backed securities at a premium over their current deflated values. By paying "hold to maturity'' prices, the government would provide troubled firms with an infusion of capital, reducing doubts about their viability and thereby restoring investor confidence. The plan in its original form was quickly rejected by both Democrats and Republicans in Congress and was criticized by many economists across the political spectrum. Congress insisted on adding provisions for oversight, limits on executive pay for participating companies and an ownership stake for the government in return for its investments. Even so, the plan proved to be strikingly unpopular with an outraged public, and on Sept. 29 it failed in the House of Representatives. But as the markets continued to plunge, a slightly altered version won the support first of the Senate, on Oct. 1, and of the House, on Oct. 3. President Bush quickly signed the bill. Shortly afterward the Plan’s course was reversed, and the $350 billion in the first round of funds allocated by Congress not to buy toxic assets, but to inject cash directly into banks by purchasing shares, an approach that many Congressional Democrats had pushed for earlier. In an initial round of financing, nine of the largest banks were given $25 billion apiece. The Treasury also used the bailout to steer funds to stronger banks to purchase weaker ones. Unfortunately, no strings were attached to the Treasury infusions, and many of the banks appeared to be using the funds to bolster their balance sheets rather than to make new loans. On Nov 12, The Treasury of State abandoned the idea of asset purchases, and said the bailout money would be used instead for a broader campaign to bolster the financial markets and help consumers seeking loans for cars or tuition and other kinds of borrowing. To the anger of many Democratic members, none of the first round was used to prevent further increases in foreclosures. An oversight panel created by the original bailout bill also delivered a round of stinging criticisms in its first report, delivered Dec. 10. The report said that the Treasury had failed to create a system to track how bailout funds were being used or to require that banks use them to increase lending and unfreeze credit markets.

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The last big chunk of the first round funds ended up going to Detroit, in $17.4 billion in emergency loans to keep General Motors and Chrysler afloat. President Bush had initially rebuffed Democratic efforts to use the financial bailout for that purpose, preferring to redirect loan guarantees meant to help factories switch to building more fuel-efficient cars. But after Senate Republicans blocked a bill that would have done that, Mr. Bush agreed to use TARP funds, while adding tough condtions for the car makers, their creditors and unions that mirrored much of what Senate Republicans had sought. On Jan. 12, 2009, the White House said that President Bush, at President-elect Barack Obama’s urging, would ask Congress to release the $350 billion remaining in the bailout fund. Troubles continued in the financial sector - both Citigroup and the Bank of America needed second rounds of capital infusions, and federal guarantees against losses totalling tens of billions more -- while Ben S. Bernanke, the Federal Reserve chairman, warned that more capital injections might be needed to further stabilize the financial system. Another centerpiece of the plan would stretch the last $350 billion that the Treasury has for the bailout by relying on the Federal Reserve's ability to create money, in effect, out of thin air. The Fed's money will enable the government to become involved in the management of markets and banks in ways not seen since the Great Depression. In the credit markets, for instance, the administration and the Fed are proposing to expand a lending program that would spend as much as $1 trillion to make up for the $1.2 trillion decline between 2006 and last year in the issuance of securities backed primarily by consumer loans. The plan's third major component would give banks new helpings of capital with which to lend. Banks that receive new government assistance will have to cut the salaries and perks of their executives and sharply limit dividends and corporate acquisitions. They will also have to make public more information about their lending practices. A Treasury fact sheet said that banks would have to state monthly how many new loans they make, but stopped short of ordering banks to issue new loans or requiring them to account in detail for the federal money. In addition, Obama officials were preparing a $50 billion initiative to enable millions of homeowners facing imminent foreclosure to renegotiate the terms of their mortgages.

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A COMPARISON OF US AND PAKISTAN’S MONETARY POLICY
Diagnostics of Pakistan economic situation is different from global and regional developments; therefore, policy responses have to be different. With the world in grip of the worst financial crisis, some sections of the society have argued for fiscal stimulus and monetary easing in Pakistan drawing parallels between the global and the Pakistan economy. It is critical to recognize that the magnitude, depth, and impact of this global crisis vary across regions and countries and that the domestic macroeconomic situation differs in each country. While a number of advanced countries are facing severe liquidity crisis, which transformed into an insolvency crisis, the macroeconomic fundamentals of these countries, to start with, Interim Monetary Policy Measures, November 2008, were in order. At the same time other large Asian countries, while being impacted by the global events, have been able to weather the storm given their strong reserve positions. In contrast, Pakistan, hit by the global commodity price shock and given the delays in pass through of this price effect, witnessed a growth in its fiscal and external current account deficits that reached unsustainable levels and alarmingly high inflation. With stagnating tax to GDP ratio, this not only enhanced recourse to borrowings from the SBP but also resulted in a fall in foreign exchange reserves, triggering depreciation in the exchange rate. Since there are significant differences in ‘diagnostics’ among Pakistan and other countries it must be recognized that the policy solutions will also be different. Considering the size of macroeconomic imbalances, the SBP remains committed to achieve price stability over the medium term and thus have to launch steeper monetary tightening to tame the demand pressures and restore macroeconomic stability in FY09. The road ahead for Pakistan, both politically and economically, will remain tortuous in 2009 with a confluence of new challenges having emerged. A more effective tackling of the militant threat, beyond the present military broadside, will remain of paramount importance, as will defuse brewing tensions with India. Although the new US President Barack Obama’s strategy towards Pakistanis not entirely clear yet, with the controversial use of unmanned drones to strike militant hide outs along Pakistan’s border with Afghanistan having continued at the start of his tenure, we believe that he will adopt a more finely calibrated approach than his predecessors. As for the economy, there are incipient signs of stabilization, but much work left to be done, particularly as far as reforming Pakistan’s rickety fiscal regime is concerned. The challenges facing the administration of President Asif Ali Zardari will not diminish in 2009, and could grow even more daunting. Tensions with arch-rival India remain heightened following the November 2008 terrorist attacks in Mumbai. Domestically, the battle against militants in the north western tribal areas is ongoing. On the economic front, although a balance of payments crisis has been averted on the back of a US$7.6bn IMF loan, the urgent need to ameliorate macro economic imbalances means that the government will be forced to tighten its belt further. While the IMF has acknowledged that this process of consolidation should not come at the cost of social stability, it is hard

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to see how the government could maintain any form of cushion for Pakistanis given its depleted resources and need to raise tax revenues. Thanks to a US$7.6bn IMF rescue package Pakistan has, for the time being at least, averted a balance of payments crisis and possible sovereign default. A process of stabilization, under pinned by tighter fiscal and monetary policy, is underway and will be helped by the steep fall in international commodity prices. Pakistan’s yawning twin deficits, in the fiscal and current accounts, should comedown tin 2009 as should inflation. Nonetheless, ongoing electricity and security problems, coupled with restrictive credit conditions and a weakening global economy - which will keep a definite capon foreign investment inflows - is likely to drag growth lower in 2009, and we accordingly forecast real GDP growth to slow to 2.5% in FY2008/09 (July-June), less than half the rate in FY2007/08and significantly below the near 7% average rate of expansion seen over the past five years. The business environment will remain highly challenging throughout 2009, largely due to the stifling energy shortage, which has brought many industries to their knees, and the parlous security situation. The government has said that it wants to attract some US$10bn in foreign investment over 2009 - much of which it believes will come from the Gulf region - but BMI is not convinced that this will be possible, given the current bleak outlook for the global economy and climate of risk aversion. A large part of this investment would be solicited for infrastructural projects and the energy sector in particular, where a 3,000-3,500MW capacity shortfall needs to be plugged before yearend. However if we are trying to compare the monetary policies of the two countries, it may be a difficult task as both the countries have other macro and micro influences working at the same time simultaneously. But we can still see how well the monetary policy is implemented in the two countries using the instruments of the monetary policy. Comparing the monetary policy of the two we can conclude the following:

UNITED STATES
a. b. c. d. e. f. g. h. Crisis response Risk management Longer-term issues Open market operations Central bank liquidity swaps Lending to primary dealers Other lending facilities Support for specific institutions

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PAKISTAN
a. Devaluation of the Rupee b. Lending to depository institutions c. Surge in import bill d. Disinvestment by foreign investors e. Depleting foreign reserves f. rising to Global commodity and food prices g. Drain of the liquidity from the financial system

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