Role of Monetary Policy

Chap 5
TYPE OF POLICIES
Monetary Policy (SBP)
To manage Money supply in order to constrain money
supply,  inflation or deflation, maintaining exchange
rate. 
Monetary Policy is made Semi annually & reported
quarterly 

Fiscal Policy (Ministry of Finance) Related to Gov

Expenditure & taxes, policies made to decline 
inflation & increase GDP growth. 
MONETARY POLICY
Overview
 Monetary policy determines the amount of money that
flows through the economy. It control inflation, exchange
rates , unemployment and economic growth
Monetary policy shows the relationship between the rates
of interest in an economy, i.e.  the price at which money
can be borrowed, and the total supply of money. 
Interest rate↑1/α (inversely proportional to) Money
supply↓ ( less money supply will lead to high interest rates
making it pricier for consumers to take out a loan).
Expansionary  Monetary Policy
Expansionary monetary policy increase money supply
A reduction in interest rates and  increase in bond prices 
Lower interest rates lead to higher levels of capital investment.
The demand for domestic currency falls and the demand for foreign
currency rises, causing a decrease in the exchange rate. 
A lower exchange rate causes exports to increase, imports to
decrease and the balance of trade to increase.

Money supply ↑, interest rate ↓, bond price ↑,

Money supply ↑ Savings ↑
Money supply ↑, demand foreign currency as compared to domestic
currency , exchange rate ↓, exports ↑ imports ↓, balance of trade ↑
Contractionary monetary policy
Contractionary monetary policy decrease money supply
Increase in interest rates and causes a decrease in bond prices 
Higher interest rates lead to lower levels of capital investment.
The demand for domestic currency rises and the demand for foreign
currency falls, causing an increase in the exchange rate. (The value of
the domestic currency is now higher relative to foreign currencies)
A higher exchange rate causes exports to decrease, imports to increase
and the balance of trade to decrease.

Money supply ↓, interest rate ↑ bond prices ↓

Money supply ↓ capital investment ↓
Money supply ↓ demand for domestic currency ↑ as compared to foreign
currency, exchange rate ↑, exports ↓ and imports ↑, balance of trade ↓
Interest rate (borrowing and lending) money
supply
Interest rate (borrowing) ↑1/α (inversely proportional to) Money
supply↓
Interest Rate(lending) and Savings
Interest rates determine the amount of interest payments that savers
will receive on their deposits.
An increase in interest rates will make saving more attractive and
should encourage saving.
A cut in interest rates will reduce the rewards of saving and will tend
to discourage saving.
Interest rate↑ Savings (lending rate)↑ 
Higher interest rates make it more attractive to save in a deposit
account because of the interest gained
  Savings(return) of lenders ↑
Interest rate (borrowing rate)
Higher interest rates increase the cost of borrowing 
Reduce disposable income and therefore limit the growth in
consumer spending. 
Higher interest rates tend to reduce inflationary pressures and
cause an appreciation in the exchange rate.
With higher interest rates, interest payments on credit cards
and loans are more expensive. Therefore this discourages
people from borrowing and spending. .
Interest rate↑ borrowing cost  ↑ disposable income ↓ consumer
spending ↓= price level ↓ inflation ↓, (more interest, less
borrowing less spending, no money in pockets so people don’t
buy anything, demand falls, price and inflation falls).
interest rate (borrowing) and Inflation
There is an inverse correlation between interest rates and
the rate of inflation.
When interest rates are low, the economy grows and
inflation increases (low interest, more borrowing, more
spending and more demand leads to higher prices). 
Conversely, when interest rates are high, the economy
slows and inflation decreases.

Interest rate ↑ , inflation ↓

Interest rate↑ borrowing cost  ↑ disposable income ↓
consumer spending ↓ price level ↓ inflation ↓,
Interest rate(lending), inflation and exchange
rate
High inflation often brings higher interest rates, which
could then cause a stronger currency.
Low inflation on the other hand will often induce central
bankers to drop interest rates and currency makes it
depreciate.

Inflation ↑ interest rate (lenders) ↑ , capital

investment ↑ , money supply ↑, price level ↓, inflation ↓
As more lenders demand domestic currency, exchange
rate ↑ 
Money supply , interest rate, savings,
increase demand , inflation
Money Supply ↑ interest rate (borrowing) ↓ spending
↑ 
Business firms respond by increasing sales (more
spending by people), demand for labor and capital
goods increases (more spending, more demand, more
supply)
Stock prices rises, firm issue equity and debt,
Inflation increase and lenders want  high interest rate