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CHAPTER No. 1
INTRODUCTION
1.1 BACKGROUND:
Raising the growth of economy, increase the level of employment and the price stability are the main objectives of monetary policy. Economic growth is an important factor for every country and monetary policy has a direct relation with economic development. Supply of money and price stabilization is control by monetary policy within a country. Central bank of the country controlled the monetary policy within the country and in Pakistan monetary policy is controlled by State Bank of Pakistan.

The main objective of SBP is the stability of financial sector and management of monetary policy in order to achieve the economic development of the country. To achieve the targeted economic growth in the country, the main responsibility of State Bank of Pakistan is to how to conduct and formulate the monetary policy with in the country. SBP choose effective monetary policy through which the government of Pakistan, attain a set of objectives oriented towards the growth and stability of the economy.

Through monetary policy SBP creates a relationship between the rates of interest and the total supply of money within the economy. Pakistan’s monetary policy aims at stabilizing economic growth through a number of channels. It influences the future expectations of economic activity and price stability. Monetary policy in Pakistan, has been supportive of the dual objective of promoting economic growth and price stability. It achieves this goal by targeting monetary aggregates in accordance with real GDP growth and prices set by the Government.

In order to attain the objectives towards the growth and stability of the economy the State Bank Of Pakistan focusing on the variable like: supply of money, availability of money, price stabilization, increasing output of the country, stability of demand of money and rate of interest. One of the important target variables of monetary Policy in Pakistan is money supply. Money supply plays a vital role in the GDP growth of a country. Monetary policy of Pakistan depends on the supply of money and set the interest rate for the economic growth of Pakistan.
The money supply of Pakistan includes the currency in circulation and demand deposits of financial institutes. In Pakistan money supply is defined on the basis of M1, M2 and M3. M1 is consider a narrow definition of money. In Pakistan M1 = Currency + Demand Deposits + other deposits with SBP. In M1 the deposits of central bank and other deposits of foreign countries is not included so SBP uses the broader definition of money supply is M2. SBP takes M2 = M1 + Time deposits + other deposits of SBP + deposits of foreign accounts of domestic resident.

In Pakistan some government and autonomous bodies raise their funds themselves. These resources are neither shown by M1 and M2. Therefore a wider definition of money has been presented by Ministry Of Finance in the form of M3. It is as: M3 = M2 + NDFC Bearer certificate + Deposits of NSS + Deposits of co-operative banks as the deposits of co-operative banks of Sindh, Punjab, Balochistan and KPK.

1.2 STATEMENT OF THE PROBLEM:
This study examine the affect of interest rate and supply of money on the economic development of Pakistan. This can be explain by different variables of the Monetary Policy work and the effect on other independent variables of the economy. The government will choose tight and easy monetary policy which result to expand and contract of supply of money and interest rate. This study reveals the outcomes of the steps taken by State Bank to control the interest rate and to increase the GDP of Pakistan whether by adopting tight or loose monetary policy within the country.

1.3 OBJECTIVES OF THE STUDY:
The main aim of this study is to examine the factor which affect the monetary policy of Pakistan.

To analyze the impact of Monetary Policy in economic growth of Pakistan.

1.4 HYPOTHESIS:
On the basis of literature review and selected data, following hypothesis have been used for the purpose of this study:
H1: Growth in money supply has positive relationship with GDP.

Ho: Interest rate has positive relationship with GDP.
1.5 SIGNIFICANCE OF THE STUDY:
This study investigates how the economic development of Pakistan will effect through the changes in Monetary Policy of Pakistan due to change in interest rate. Interest rate of Pakistan is become the most important topic for the monetary policy of Pakistan because it effect the growth and income distribution. In this study we examine, the factors which effect the money supply within the country and the effect of different factor influence the economic growth of Pakistan is also focused. We also examine the effect of decreasing the interest rate and the increase in supply of money to maximize the level of economic growth of the country. This study clearly establish a link between the monetary policy and the GDP by using interest rate, inflation rate, supply of money and price stability . Whether the policy is tight or loose the interest rate will effect the monetary policy. Other monetary phenomenon also effect the overall growth therefore this study also determined whether and how the change in money supply effect the GDP in Pakistan and the price stability in economy.
1.6 ORGANIZATION OF THE STUDY
The outline of the study is as follows: Chapter 1 gives the introduction about the monetary policy conducted in Pakistan and about State Bank of Pakistan, an overview about money circulation, statement of the problem, main objectives and significance of the study. Chapter 2 presents brief review of literature on the effect of monetary variables on the monetary policy of the economy. Chapter 3 describes the monetary policy followed in Pakistan since 1980. Chapter 4 shows the data and methodology used in the study. Chapter 5 shows the result of the study. Chapter 6 represent the relation of monetary policy with its variables.

CHAPTER No. 2
REVIEW OF LITERATURE
2.1 INTRODUCTION:
Monetary policy in an underdeveloped country like Pakistan plays an important role in increasing the growth rate of the economy by changing the supply of money and interest rate in order to control inflation in the economy. In this chapter the importance of monetary policy within a country in light of available literature to explain the relationship of GDP growth with Money Supply, interest rate, inflation rate and price stability is discussed with the help of available literature which has been given by different economists.

2.2 REVIEW OF LITERATURE :
Abdul Qayyum (2002), according to him, the prime objective of Monetary Policy is to control inflation rate in the economy by controlling the interest rate. Changing in the level of expenditure, investment and demand of money is directly influenced by interest rates. Due to change in interest rate saving rate of individual and lending rates of firm will change and this change directly effects the GDP of a country. In case of Pakistan the main goal of monetary policy is to achieve inflation rate set by Federal Government.

Hafeez, R., ; Imtiaz, A. (2002), said that Monetary Policy is formulated to achieve the targeted economic growth. Monetary Policy used money supply as an instrument to set the economic growth of a country, the variations in money supply is apply to the economy according to the requirement employment and price stability. In Pakistan monetary policy is designed to control monetary assets in such a way to get the targeted growth rate of GDP. To provide necessary fund for the development process credit given policy is also used in Monetary Policy.

Hameed G, et al. (2012), elaborated that the objective of Central Bank is to stabilize the value of money in the economy by applying an efficient Monetary Policy. The objective of economics policies of any is to increase the public welfare and the monetary policy focus this by promoting the interest rate and price stability. Monetary policy controls the money supply and interest rate in such a way to get the high level of economic growth. Interest rate negatively effect the GDP rate of country and money supply positively effect the GDP rate.
Waseem Ahmed Khan (2014), analyze that Interest rate play an important role in monetary policy of any country because interest rate directly affected the savings and investment of people. SBP use interest rate as an important tool to manage all other activities in the economy. When State Bank increase the interest rate the saving of the peoples will increase and investment will decrease. When SBP decrease the interest rate it will decrease the saving of peoples and increase the investment.

Irfan, H. ; (2011). The Monetary Policy of an economy is defined by the steps taken by the government or central bank through which it controls money supply, money availability and interest rate in such a way to get price stability and growth in the economy. Interest rate create a strong relationship with monetary policy because supply of money in the economy is managed by interest rate. Monetary policy uses economic growth, output and employment to control interest rate with in the economy.

Saif Ullah (2012), said that for any country the most important macroeconomic objective is the economic growth and economic growth directly effected the Monetary Policy. For this purpose State Bank of Pakistan determine the monetary policy which is most desirable for attaining the objective for the country by controlling inflation. SBP controlling the economy through variation in the supply of money by increasing or decreasing interest rates. Increasing interest rates decrease the supply of money and negatively effect the economy.

Kamran (2014). Interest rate and rate of inflation inversely related with GDP of a country. Changes in interest rate strongly affected the rate of inflation in the country. High inflation in the economy is due to high interest rate which decrease the economic growth, low interest rate results low inflation which is favorable for the economic growth. Increase in inflation severely effect the economy of Pakistan, SBP should adopted tight monetary policy by decreasing interest rate which results the reduction in inflation rate.

Bojan ; Lovre (2012). Supply of Money creates a relationship between level of income, GDP and the interest rate of the economy. Money supply creates a positive relation with income and negative relation with interest rate. By increasing the supply of money in the economy the income level the economy starts to increase which result to decrease the interest level of the economy. Decrease in interest rate not only favored the economic growth it also stabilize the supply of money in the economy.
Imran Sharaif Ch. (2015) analyzed that the strength of monetary policy is depends on the relationship between money supply and inflation. Supply of money plays important role to control inflation rate and to increase level of growth. Due to increase in the prices of oil in 2005 inflation rate increases and the increase in prices resulted inflation rate to reaches at peak level in 2008. The main cause of inflation is money supply, increase in interest rate and money supply reduce inflation in the economy of Pakistan.

Iqra Ihsan and Saleem Anjum (2013), analyzes that the monetary policy of developing country depends on the total money supply and the interest rate which are two main aggregates of MP. Money supply has a powerful effect on the economy growth, increasing in the money supply results decreases the interest rates and increases the investment level in the economy. GDP of Pakistan depends on the money supply within the country and to achieve the targeted growth in Pakistan, SBP increases money supply in the country.

Khan ; Fida, H. (2005). point out that the performance of monetary policy in Pakistan depends on monetary aggregate. The effective role of monetary aggregate create effective relationship between monetary policy and macroeconomic variable such as national income, interest rate and price level of the country. Supply and demand of money are the main monetary aggregates , changes in currency circulation changes the income of people. Development in economy directly affected by change in monetary aggregates.

Abbas (1993), examined that variation in monetary policy take place to maximize the level of output and price stability by changing the supply of money in the economy. In Pakistan total monetary assets is controlled by monetary policy to achieve the projected level of growth in GDP. By increasing the money supply, the level of currency and bank reserves is also increased in the economy. Spending in the economy reaches to the high level due to increase in currency and the economy become slow due to high growth of reserves.

Pervaiz Janjua (2014) , focusing that applying tight monetary policy the lending of money by the SBP decrease by increasing the interest rate which result to decrease the level of investment that effect the growth and output level of the economy. Tightening of monetary policy directly affected the supply of money. To stabilize the supply of loans to the banks, monetary authority in the economy stability of interest rate, because along with the changes in bank’s loan, economic activity also affected by the change in interest rate.
Muhammad Ayyoub (2011), explore the relation between inflation and growth of the economy as inflation badly affected the income distribution and economic growth. Increased in money supply is correlated with high rate of inflation which result low level of investment along with this inflation also creates negative relation with GDP growth. Any increase in the level of inflation inversely effect the GDP growth and it become harmful for the GDP growth of Pakistan, price stability play a vital role in maintaining economic growth in the country.

M. Khalid (2005), indicate that for maintaining and achieving price stability in the economy inflation targeting (IT) strategy is selected as a monetary policy objective. Through Inflation Targeting (IT), central bank can choose appropriate monetary objectives to control inflation. Due to increase in inflation rate central banks adopted flexible monetary policy by controlling price, increasing investment or by decreasing rate of interest, the focus is given to price stability for achieving growth in the economy.

Khan and Sonia (2014), explain the relation between money supply and inflation, increase in money supply causes high rate of inflation. SBP controlled inflation through an effective monetary policy, rise in inflation is controlled by money supply in the economy. For achieving high level of growth SBP apply loose monetary policy which generate inflation in the economy. By decreasing borrowing level of government from financial institute SBP bring down the high rate of inflation.

Abdul Qayyum (2006), showed that economic growth of the country suffers due to high level of inflation and under high inflation rate government policies cannot run smoothly. In Pakistan, excess growth in money supply rises the level of inflation. Monetary policy use money supply as an important instrument that initially effect the GDP growth then hits the inflation in the country. Due to increase in money supply thee level of inflation increases, to reduce inflation tight monetary policy is adopted by SBP.

Abid Rashid Gill (2010), The total money supply in an economy depends on the circulation of money . In case of Pakistan where economic growth fluctuates so frequently the determination of supply of money is difficult. If the supply of money is not stable then the demand of money will also unstable which will affects the relation between GDP and inflation rate this will result weak monetary policy. The efficiency of monetary policy depends on the supply of money.

Above discussion shows that monetary policy creates direct relation with GDP growth of a country. Variables of monetary policy such as money supply, interest rate and inflation had great impact on the economic growth in economy. Inflation directly affect the economic growth and money supply with interest rate also affect the GDP growth in economy.

CHAPTER No. 3
Pakistan’s Monetary Policy
INTRODUCTION:
The process through which central bank control money supply in the country is Monetary Policy of that country. Main goal of monetary policy is to maintain inflation rate and interest rate in the economy, further more central bank uses monetary policy to achieve the targeted economic growth and price stability in the country. Monetary Policy based on the relation ship between interest rate and money supply in the economy and use different variables to control both of these, like inflation rate, growth in economy and exchange rate.

Central bank may adopt easy or tight monetary policy depends on the economic condition of a country. By adopting easy monetary policy, the rate of money supply rapidly increased by the central bank and interest rate starts decreasing . Through which investment level and GDP rate increases in the economy and country will achieve the targeted economic growth. Where as when tight monetary policy adopted by central bank the money supply decreased and interest rate increased which results decrease in investment level and economic growth affected badly.

Money supply used as an important variable of monetary policy and central bank creates variations in money supply according to the requirement of level of output, price satiability and employment with in the economy. In Pakistan, State Bank designed monetary policy to controlled total monetary aggregates keeping in view to achieve projected level of growth rate of GDP, maximum level of output, employment and price stability in the economy.

3.2 MONETARY POLICY IN PAKISTAN:
In Pakistan monetary policy is formulated to achieve targeted economic growth and to maintain inflation level in the country. In Pakistan, SBP is responsible to conduct and manage the monetary policy, for achieving the monetary stability in the economy and focus to control inflation rate. SBP use money supply as an important variable of monetary policy and designed monetary policy in such a way to control monetary assets1 in order to get sustainable growth rate of GDP and price stability in the economy.

In Pakistan formulation of monetary policy changes with the economic condition in the country SBP creates variation in money supply keeping in view the requirement of employment, level of output , price stability in the economy and to keep inflation within the limits. Changes in the interest rate by SBP directly affected the money supply, inflation rate and credit availability in the economy. In case of Pakistan, monetary policy attain the economic growth by targeting monetary aggregates.

In 1947 Pakistan was being a poor country and industrially and economically backward country but with many economical changes the GDP rate was better than past. Impressive achievements in the field of agriculture, production in industry,
1Monetary Assets: Monetary Assets in Pakistan is examined by:
M1 : Currency In Circulation + Demand deposits with schedule bank + Other deposits with State Bank of Pakistan.

M2 : M1 + Time deposits with schedule banks and foreign currency deposits.

M3 : M2 + NDFC bearer certificate + Deposits in NSSs + Deposits of federal bank for Co-operatives
consumption and income changes the life style of many people. At the same time the
economy of Pakistan is suffering from different political disputes, increase in population and other internal problems like terrorism, load shading, inflation etc. Inflation rate badly affect the economy of Pakistan.

Since 1947, Pakistan’s economy have pursued different path. The first step that has been taken by Govt. of Pakistan is the best utilization of agriculture product and establish consumers goods industries. Industries rapidly grow in Pakistan between 1949-1958 as this was the time of struggling for a new country. The economy become stable and GDP growth rate start to increase in 1960’s. For economic development an energetic approach has been adopted by the government which result in a rising rate of economic growth.

In the first half of 1970’s the war effect and separation of East Pakistan in 1971, devaluation of Pakistani rupee, increase in oil prices, drought, massive floods, increase in inflation, decrease in investment and huge failure in cotton crop badly affected the economic condition and GDP growth rate of Pakistan. In second half of 1970’s from 1977-1979 steps has been taken to increase GDP rate and to stabilize the economy. Investment level is increase in medium and large scale industry, agriculture sector is improve and business confidence in private sector is restore.

3.3: THE DECADE OF EIGHTIES:
In 1980’s the Pakistan’s economy was characterized by the high level of growth rate (GDP) and it was considered a most developed country of South Asia. In 1980s government tries to manage the monetary policy instrument in such a way to achieve the maximum level of growth. For this purpose steps has been taken by the government to stable the market and switch over to the more efficient monetary policy. SBP increased Monetary assets , interest rates decreased which result increased in borrowings from bank.
In 1980’s economy is geared up, increased momentum in GDP growth rate has been carried forward and process of economic revival is continued. Impressive rise has shown in agriculture sector as weather condition is favorable and government took part for improving productivity in agriculture. Industrial sector also record high growth in both small and large scale as compare to last years. During the year monetary policy also geared to attain the objective of productive investment, attainment of high growth rate in all sector, controlled inflationary pressure and price stability.
SBP adopted expansionary monetary policy and increase money supply at the start of 1980. Government Islamized the economy for this purpose interest rate is eliminated and Zakat system is introduced in the banking and financing sector of the country. Small loans has been given in the field of agriculture and industry that improve economic performance and increase in productivity meantime commercial banks gives credit to public and private sector to increase investment in the economy. Pakistan has recorded impressive growth rate during the period.

Efforts have been achieved to achieved price stability in 1982 for this confidence of private sector restore. Production in private sector was faster, growth rate increase, prices are stable and inflation start to decline, growth in production increase availability of goods and services that reflect high rate of economic growth. Historically Pakistan experience three phases of growth and inflation: 1. High growth accompanied with low inflation in 1960’s. 2. Moderate growth and high inflation in 1970’s. 3. High growth and moderate inflation in 1980’s.

The outstanding performance of the economy is continued in 1986, remarkable price stability was achieved in 1986, GDP rate was increase and inflation rate decrease to 3.5 % the lowest rate ever recorded since 1969. Monetary expansion is carefully regulated in the economy for keeping inflation at low level and increase in GDP growth rate. Overall growth rate in the economy of Pakistan is increased due to better income distribution, improvement in production process, low inflation rate and availability of large number of goods and services for consumption enables people to better access to these goods and services.

Inflation starts to increase in 1987 due to monetary expansion and increase in the prices of goods. Expansion in monetary assets in more then output in the economy, to control this expansion and to implement sound monetary policy SBP appointed NCCC2. Inflation rate is measure on the basis of CPI3 (consumer Price Index) that increases due to shortage in the supply of main crops, vegetables and fruits. Impact of drought, heavy rain fall and flood reduced supply of main agriculture commodities. During the month of April / May in 1987 heavy rain fall damaged crops of wheat, potato and onion which are ready to harvest.

2 National Credit Consultative Council (NCCC): The monetary policy in Pakistan is executed primarily through a credit plan, prepared every year by NCCC under the governor of SBP. The credit plan which set the limit to expansion in money supply is formulated keeping in view the requirement of money credit for the projected growth of GDP.

3CPI: the instrument to measures inflation. It is used to estimate the average variation, it is a monthly and yearly estimation of prices of house hold good and services. It report about rising and falling of prices.

The production of pulses, gram and some vegetables become low due to reduction in cultivation area which is affected due to drought meantime prices of milk powder and edible oil is increased in international market. Drought condition, heavy rainfall, floods and excess price of key import like milk powder, oil etc become a main factor of increasing the price level that raised inflation rate in the economy. Economy faces same condition in next year, CPI recorded increase during the year and inflation rate4 become very high in 1988.
Excess rainfall and flood washed away major part of crops, decreases production level in agriculture sector, production in small and cottage industries also affected. These factors decreases level of investment and production in the country which influence negative impact to economic rate of the country resulted decreases in GDP rate and prices of consumer goods increase. The major concern of the government is to contain prices of essential goods within reasonable limits. Government has to adopted price stabilization policies to improve availability of essential goods in less price and to restrict monetary expansion.5
New government take hold in Dec’ 1988 and immediate measures have been taken to control price situation and supply of essential goods. Government owned retail outlets as utility stores and make it possible to provide necessary goods in reasonable prices. In 1989 demand and supply of essential goods become better due to improved production in agriculture sector and at the same time tight monetary policy is adopted
4Infaltion Rate: Rate at which prices increase over time, resulting in a fall in the purchasing value of money.

5Monetary Expansion: A policy by monetary authorities to expand money supply and boost economic activities by keeping interest rate low to encourage borrowing by companies, individuals and banks.

by SBP that start deceleration in inflation pressure. This year was regarded as a year of growth with economic stability.

The decade of 80’s start with achieving growth rate in the economy which become very low in last years, prices of goods was stable, economic condition improved, production of commodities increase, inflation is controlled due to high growth rate. Production sector is improved, incentives has been given by government to restore production level both publicly and privately.

3.4: THE DECADE OF NINETIES:
The decade become an eventful and difficult for the economy of Pakistan. Country’s economy deeply effected by Gulf crisis from 2nd August 1990 till 28th February 1991 when Iraq occupied Kuwait. Pakistan faces a loss of seven hundred million dollars due to loss of exports in Gulf market meanwhile consumer prices also increase because Pakistan imports oil on high prices. Inflation rate and money supply increases due to increased in consumer prices. In this difficult circumstance Pakistan trying to maintain severe pressure on balance of payments by controlling trade.

Inflation rate increases sharply in the economy due to unstable price situation and increase in oil prices. Monetary expansion exceed at the same time because of increased in government borrowing, there is a need for tight monetary policy to control inflation and reduce deficit financing6. In spite of severe strain face by the economy the performance of economy has been satisfactory and respectable growth is shown because GDP rate is estimated to grow due to increase in agriculture sector and
industrial sector.

6 Deficit Financing: Practice in which government spend more money then it receive as revenue.

After the general elections in 1990, Nawaz Sharif’s government came to the power for
the first time. The government come into work on 6 November 1990 and immediately
start working on economic and social reforms, the government’s goal is to transform the economy to achieve higher growth path. Government implement privatization of banks and industrial units and economic liberalization programe to control stagflation7 in the economy, taxation system, trade and payment system was reformed, industrialization sector encourages particularly in rural and under developed areas.

By the steps taken by government economy starts to improve in 1992, GDP rate increases and gradually economic conditions become better, investment level are higher and inflation rate starts to decelerate but not come to desire level due to monetary expansion, rupee depreciation, short fall in production of some essential items and increase in CPI due to increase in prices of some essential items of a common man. At the same time borrowing by the government sharply increase which create higher expansion in monetary assets and domestic credit.

The objective of high growth and financially stability restrain by some unexpected shocks in 1993. GDP rate decreases badly due to decline in agricultural output, excessive rain with devastating flood and attack of leaf curl virus disease decline production of cotton. Production of sugarcane, rice, maize and wheat also affected by flood and unfavorable weather conditions, low growth rate in agriculture sector
increases CPI which increases inflation rate. Economy is also effected due to change
in political affairs .

7Stagflation: Situation in which inflation rate is high, economic growth rate slow and unemployment remains steadily high.

Due to the political instability, increase in corruption in governance, frequent change in government, week governance and worst law and order situation GDP growth rate
badly effected in 1993. The fiscal indiscipline and expansion in domestic credit
beyond limits reflected loose monetary policy that generate severe inflationary pressure. The new elected government come to power in 19th October 1993 and focus macroeconomic stability in the economy. Tight monetary policy is adopted to control monetary expansion and appropriate measures have been taken to control availability of credit.

The performance of the economy improved in 1994, GDP rate start to grow after decline in last year. The monetary policy aimed to tight demand management8 and to ensured availability of credit to the private sector for productive purpose. SBP use tight monetary policy, decreases money supply and interest rate in the economy but inflation rate remain high because of high price of petroleum product. Monetary policy geared in coordination with macroeconomic policies to achieved high growth and to stable the economy in 1995.

Performance of economy is improved in 1995 and 1996, GDP rate grow, SBP pursue tight monetary policy, money supply decreases, inflation rate remains high because CPI rate increases as rise in prices of agriculture product and edible oil is recorded. By government effort macroeconomic stability is achieved and augmenting the supply
of essential goods brings moderation in inflation rate but political instability effect the economy at the end of 1996. New elected government inducted on February 1997 and the year become challenging for Pakistan’s economy.

8 Demand Management: A planning methodology used to plan and manage the demand for goods and services.

In January 1997 autonomy of SBP was further strengthen, after this SBP have full authority to conduct monetary policy of Pakistan and also to oversee the affair of
entire financial system. Along with this Pakistan Banking Council were abolished and merged with SBP. SBP conducted monetary policy with the objective to control inflation, tight monetary policy adopted but the performance of economy was below expectation. GDP rate decline because untimely rain affect production in agriculture sector and hot and dry weather in late summer promote pest attack in cotton crop that decrease export of cotton product.

Monetary expansion is within the target but budget deficit9 and balance of payment were very much higher due to decrease in export along with this financial crisis badly affect the economy of Pakistan due to East Asian Financial Crisis in July 1997. Pakistan local currency went down, bank heavily borrowed in foreign currency and most importantly foreign investor loss confidence in Asian market including Pakistan. These crisis effect Pakistan’s external sector as faces loss in export’s earning and access to international market was limited.

All these factor increases inflation rate to double digit, surge of inflation seriously concern with price and monetary stability, encourage accumulation of non-financial assets, disturb allocation of resources and affects economic efficiency. Steps has been taken by government to control economy of the country and Pakistan witnessed upturn in growth rate of economy in 1998. Reforms has been made by government to recover production in agriculture and industrial sector. Impressive production record in agriculture sector by which prices of commodities declined.

9Budget Deficit: Situation where government is spending more than it receive in taxation and force to borrow from the private sector.

Pakistan is trying to improve its economic sector meanwhile on May 11 ; 13th 1998,
India has conducted five nuclear tests which threatened national security of Pakistan, the security compelled Pakistan to respond in same language. Pakistan conduct its nuclear test on 28th May 1998 by this action Pakistan faces economic difficulties in coming months because economic sanction has been imposed on Pakistan by some countries, which create serious difficulties for country’s balance of payment and directly impact domestic economy of Pakistan.
Despite this government prepared economic package to overcome economic and financial requirement of the country, government recovered economic situation by increasing growth in production sector. Strong growth in agriculture and industrial sector revived GDP growth, the GDP rate increases due to higher growth in commodity producing sector. Improved supply situation reduces prices of essential goods in market that decline inflation rate to single digit number, SBP adopted tight monetary policy by which overall money supply come to the targeted path and also increase domestic credit to improve economic growth.

After facing difficulties, economy of Pakistan restore stability in 1999, increase is registered in GDP rate and by improving supply situation in manufacturing sector and satisfactory performance in agriculture sector. SBP pursue tight monetary policy by reducing money supply and credit to government sector also increase availability of credit to private sector by decreasing interest rate. Prices of essential goods are stable that decrease CPI rate and inflation rate further decline in 1999 it was key achievement of government, this has been a lowest inflation rate in last two decade due to strong recovery in agriculture production, improved supply of essential goods and containment in the growth of money supply.

The growth performance of Pakistan’s economy is deteriorate in 1990’s, investment level decline due to political instability. Pakistan faces decline in economic growth, severe imbalance in macro-economic indicator, the economy of Pakistan remained under stressed during the decade due to imbalance in external sector, high aggregate demand, low growth rate of GDP but macro-economic indicator stable at the end of nineties. The main features of this decade was the establishment of more private bank, privatization of commercial bank, enhancing the SBP financial autonomy, achieving price stability and sharply decline in inflation rate.

3.5: THE 2000’s:
The structural reform program designed and initiated in 1990s, was continued and pursued during 2000s to put the economy on the path of recovery. The last decade suffered with various macroeconomic imbalance in Pakistan like disputes of internal politics, confrontation with neighboring country India, persistent increase in supply of money, periodic crisis of balance of payment and high inflation rate. New government take initiative to manage severe issue of financial stability, improved external balance, macroeconomic instability, economic stabilization and to place the economy on the path of high growth.

10Account Deficit: Measurement of a country’s trade where the value of goods & services it import exceed the values of goods and services it export.

Fiscal year 2000 start with the steps, taken by the government to reduce budget deficit and current account deficit10 also target low inflation rate, GDP rate increases although agriculture sector suffered by drought condition but production in manufacturing sector is impressive. Tight monetary policy is adopted by SBP to maintained price stability
but inflation in food and non food items are slightly higher because of increase in prices
of major crops due to domestic shortage and rise in price of oil and transport responsible for high rate inflation in non food items.

The pace of economic recovery in Pakistan badly affected by event of 11 Sep 2001, GDP rate of Pakistan decreases badly due to continuation of drought & 11 Sep event, Pakistan faces serious difficulties in foreign investment, export, import, industrial production and privatization program badly affected. At the same time development in monetary sector have been satisfactory and deceleration in inflation rate is recorded due to decline in CPI rate by improving supply of food items in the country at less price. Although the rise in price of oil put pressure on inflation but the pressure is controlled by tight monetary policy and improved supply situation in the country.

After the economy downturn in 2001 by the event of 11th Sep, the year 2002 shows recovery in global economy as well as Pakistan’s economy, the country has witnessed significant improvement in macroeconomic indicator11. Measures has been taken to improve production sector and all three major sector of economy (agriculture, manufacturing and services) respond positively, impressive growth recorded in agriculture sector as drought problem is solved by improving water availability and heavy rainfall increases production of major crops.
11Macroeconomic indictor: The indicators that shows economic performance of a particular region or country and have significant impact on the market, like: GDP rate, Money Supply, Consumer Price Index etc.

Growth in industrial sector accelerated by improving macroeconomic environment and by financing consumer at reasonable interest rate. Growth level in export become strong and supply situation in the country is better by improvement in production sector. With this notable achievement of the year is low inflation rate despite easy monetary policy stance inflation remained under control which is because of better supply situation and stabilize price of essential commodities. By adopting easy monetary policy SBP increase money supply and declined interest rate to promote investment and to installed new industries in the economy that increase employment opportunities and per capita income of individual.

The economy is on the path of high growth, economy shows impressive growth in 2003 GDP rate increases due to enhanced performance of industrial sector and increase in production of essential goods. SBP continued its easy monetary policy stance with a view to maintain strong growth momentum for this interest rate become investment friendly both for business and middle class borrowers also supply of money increases in the economy. Despite this improvement in production sector and adequate availability of consumer goods at reasonable price keep low inflation rate and maintain price stability in the country.

After slow growth in 1990’s impressive growth is shown in Pakistan’s economy, during the year 2004 macroeconomic indicators show marked improvement and the main achievement is the fastest pace in real GDP growth. Along with this economy shows sharp decline in domestic and external debt, double digit growth in export and import (balance of payment become better), market capitalization increase, improved performance of stock market, investment level increases and reduction in fiscal deficit in FY 2004.

GDP rate was surpassed the targeted growth by improving agriculture sector and industrial sector, rise in GDP leads to rise in average income of people. Such increase in income one hand increases consumer spending and on the other hand raise inflation rate in the country. The sharp upturn in inflationary trend also recorded in 2004 which is caused by increase in domestic demand and supply shock12 of principal commodity, easy monetary policy stance is adopted to start a stagnant economy by increasing money supply that also caused rise in inflation.

Pakistan inflation’s rate start to decline in 1998 – 2000 by improving supply situation and by strict budgetary measures, further reduce in 2002 and low level of inflation has achieved in 2003 which is a result of strict fiscal discipline and lower budget deficit. Inflation start to rise in 2004 due to increase in price of wheat, mismanagement in wheat operation and increased supply of money. To control inflation SBP changes monetary policy stance from easy to gradually tight monetary policy and increase interest rate in the start of 2005, tight monetary policy reflect rise in weighted average (WA)13 lending rate.

12Supply Shock: An event that suddenly increases or decreases the supply of commodity or service and this sudden change affects prices of good and services.
13Weighted Average Rate: The rate charged by the banks on the loan given to the people during a given period of time.

14Commodity Producing Sector (CPS): Sector which produce good for the growth of the economy its include agriculture and industrial sector.

Pakistan maintained its growth momentum in 2005 and delivering solid economic growth by restoring confidence of new investment supported by strong credit growth to private sector and by enhancing production in Commodity Producing Sector (CPS)14. Pakistan’s economy is affected by massive earthquake of Oct 8, 2005 and increased oil prices at the end of the year that put severe strain on the country’s trade. Earth quake caused damaged to property, hospital, school, infrastructure and loss of over 70,000 lives, reconstruction of affected areas and rescue and relief operation put severe stress on Pakistan’s budget.

Meantime higher inflationary trend is continue in Pakistan due to increasing pressure from demand and supply side, rising level of income strengthened demand of domestic goods that sharply upward the prices of essential commodities. Supply side emanated from various factor including increase in support price15 of wheat, inter-provincial ban on movement of wheat that increases price of wheat and prices of other food and non food items also registered sharp increase include increases in energy and oil prices.

Despite these constraints Pakistan’s proved itself to face shocks of extra ordinary proportion, steady growth record in GDP rate. Pakistan’s growth performance is impressive all sector of economy significantly contributed to GDP growth and remarkable growth recorded in service and industrial sector. Government took measures to control prices of goods by expending supply of essential items through the outlets of Utility Stores Corporation (USP), relief is given to low income groups by providing wheat and sugar in lower prices through USP outlets.

15Support Price: The price at which the government will purchase commodities, especially farm produce, in order to maintain a certain price level.

16Trading Corporation Of Pakistan (TCP): It is Pakistan’s most prestigious public sector organization, mainly responsible for export and import of commodities. It also issues tender for import and export of agriculture products.

Pakistan’s economy delivered solid economic growth and continue to maintain its GDP growth rate in 2006, the growth is based on CPS of the economy. Improvement is also shown in financial sector of Pakistan, SBP changes its monetary policy stance to aggressive tightening policy for reducing excess demand which cause increase in prices. Inflation comes down by a combination of tight monetary policy, increased interest rate and by improving supply of goods. Government also take measures for price stabilization such as liberalizing imports, reform for increase agriculture product, improvement in marketing mechanism and by opening organization like USC and TCP16.

SBP changes its monetary policy over the last years switching from an easy (2000-2003) to broadly accommodative stance (2003-2004) and then from a gradual tightening (2004-2005) to an aggressive tightening stance (2006-2007). Economy has maintaining slow and steady growth for the last five year in a row till 2007 with tight monetary policy, but money supply increases sharply the factor that contributed increase in supply of money was sharp increase in Net Foreign Asset (NFA) to improve country’s balance of payment and higher government borrowing for budgetary support.

Year 2008 was difficult year for Pakistan’s economy because Pakistan faces many political and economical events that badly disturb economic growth in Pakistan. Pakistan’s economy faces deceleration in growth, rise in inflation (particularly food inflation), widening of trade and fiscal deficit, disturbed political condition, unstable law and order situation, excess demand of goods, supply shocks, soaring prices of oil, increase in prices of food and other commodities. All these events adversely affected the key macroeconomics fundamentals of Pakistan in 2008.

GDP rate badly decline in 2008 because of poor performance of agriculture and industrial sector, less than satisfactory performance has been responsible for slower economic growth meanwhile sharp increase is recorded in inflation rate. Poor performance of agriculture sector affect availability and price of major crops in market, sharp increase is shown in prices of some key food items that reflect highest increase in food inflation with this value of Pakistani rupee comes down due to which price of fuel and other import commodities become high.

SBP tighten the monetary policy and increases interest rate to control money supply and inflation in the country on the other hand government is trying to ensure adequate supply of essential food items by encouraging domestic production. To provide relief to common man, government increased the scale of utility stores to provide essential good at less price, steps was also taken to control petroleum prices to reduce budget deficit, to improve production level and to curtail aggregate demand.
Year 2009 remain difficult year with continuing challenges, growth recovery is relatively weak but inflation rate decrease by growing output level in agriculture and industrial sector. Monetary policy stance is neutral rather than tight, monetary expansion witnessed in 2009 due to higher level of credit from government sector and credit from private sector is not growing fast because of high interest rate by SBP. Improvement in agriculture productivity was the key to mitigation of food price inflation.

Since last three years the economy of Pakistan has been undergone from stabilization phase. Macroeconomic stability and generating a platform for providing jobs is necessary and important part of growth. Due to increase in oil prices, energy crises, shocks of flood and heavy rain in the country affect the commodity price and supply of goods due to which inflation rate remains high and GDP rate decline in 2010. SBP adopted tight monetary policy to control inflation and raised interest rate, government also taken administrative steps to enhance supply of essential commodities like sugar, edible oil and pulses etc.

Year 2011 was challenging year for Pakistan economy but recovery in economy shown in the year, heavy rain in Sindh and Balochistan affect agriculture sector meanwhile improved production of cotton, sugarcane and rice crop fulfill the damage in agriculture sector. Production in industrial sector also improve by controlling law and order situation and energy crises. Incentives has been given by government to recover commodity producing sector (CPS) but improvement in service sector contributed more to raise GDP rate of the country.

Poor law and order situation, energy crisis and increase in government borrowing to finance budget deficit adversely affected the economic condition also raised inflation in the country. In Pakistan monetary management mainly focused on controlling inflation, SBP continue tight monetary policy to control inflationary pressure and to suppressed aggregate demand government’s effort to rehabilitate agriculture sector. Increased production and investment level control supply and demand of essential goods that shows decline in CPI rate by which inflation start to decline but still in double digit.

17 Large Scale Manufacturing: Sector where more units of goods and services are produced on a large scale.

FY 2012 shows improvement in the economy, on a positive note inflation fell significantly to single digit and LSM17 shows sign of recovery. The growth in industrial sector increased by recovering large scale manufacturing, in amid of severe energy crisis LSM performed well. Performance of agriculture sector remain good due to better availability of seeds, fertilizers, timely rain and moderate temperature throughout the year increased crop productivity that improve country’s GDP rate. The growing economy attract domestic and foreign investor to invest in the country which increase production, employment and stability in the economy.

SBP adopted an expansionary policy stance for promoting economic growth and price stability, for revival of credit to private sector SBP increased supply of money and decreased interest rate. Government borrowing for budgetary support and commodity operation was declined and SBP enhanced credit to private sector that increased investment level in the country. Better supply situation of food and non food items brings stability in the prices of various domestic commodities that decline inflation rate in 2012.

Pakistan succeeded in attaining 4.37 % GDP growth rate during FY 2013 which is highest level of achievement since 2008, quantitatively and qualitatively performance of Pakistan is improving and touched all sector of the economy. Government took incentives to enhance productivity and scientific and technological development introduced in three major sector of the economy namely agriculture, industrial and service sector provide support to improve economic growth. Present government take steps for removing energy shortage, create conducive investment climate and boost exports.

During the year monetary side also witnessed positive development, SBP reversed its policy stance to tight policy and increased interest rate, increased money supply decreased net government borrowing. Improved supply position of essential commodities, declining price of imported items and enhance availability of essential commodities with control price kept inflation rate in single digit. Policies introduced by the government to control budget deficit kept inflation rate in limits with this appreciation of Pak rupee, improvement in Net Foreign Assets (NFA), better monitoring of prices and easing smooth supply are positive indicator to control inflation.

Revival of growth that start in 2013 has accelerated in 2014, growth oriented program pursue by the government and due to continuous effort the economic condition start improving. FY 2014 registered some remarkable achievement, overall macroeconomic situation improved, internationally decline in oil price provide relief to common man, investment increased in the country that increase GDP rate. Broad based momentum recorded in growth and all three sector of CPS contributed in the improvement of economic growth.

SBP continue its monetary stance with tight policy, despite of tight monetary policy credit to private sector increased in the year with this SBP kept its monetary expansion in safe limits in order to maintain price stability. Market prices of essential consumer items decline by falling oil prices in global market and common man get significant relief in their cost of living. Better supply position of essential items and lower fuel price bring price stability and lower inflation in the economy.
Economy of Pakistan maintained its growth momentum in 2015 with growing GDP rate, major setback is shown in agriculture sector because of decline in cotton production which is compensated by remarkable growth in industrial and service sector. The government sternly focused to resolve energy issues and pursue growth oriented economic policies in order to achieve macroeconomic stability. Decreased in petroleum prices and launching of CPEC create new history in economic development of country.
Monetary policy is shifted from tight to easy stance by SBP and decreased interest rate that boosted confidence of business community. Sharp decline is shown in inflation rate which become the lowest level since 2004 that achieved by better production of minor crops, better supply of essential items and by maintaining the price stability. Federal and provincial government took measures to ease the prices in order to give benefit to common man in the country.

Pakistan’s economy performed impressively and its economic fundamentals has gained further traction during the FY 2016. Macroeconomic indicator shows remark improvement in outgoing FY, GDP rate increases, agriculture sector has witnessed strong recovery, interest rate becomes low with easy monetary policy that raised credit to private sector and inflation rate remain in single digit due to better supply position and regular monitoring of prices by NPMC along with DPCC.
Decades of internal political disputes and low level of investment have led to slow growth and under development in Pakistan but despite of difficult monetary management due to longstanding structural issues, positive development is shown in most of the economic indicators. Due to effective measure taken by government during the period 2000-2006 and 2013-2016 noticeable economic turnaround has been seen in Pakistan.

CHAPTER # 4
DATA ; METHODOLOGY
4.1 INTRODUCTION:
Research is an expanded article that reflect the views regarding to the topic, it presents arguments and interpretation related to the topic. Research involves surveys in related field of knowledge in order to get best possible information regarding to the topic. Research is a systematic and scientific method of collecting information on the specific topic and use of quantitative or qualitative technique to get best result in a selected field.
The purpose of research is to find out the answers of the questions about the topic through a scientific procedure. The result of the research is based on the sources and nature of data. This study is based on the valuable factors that affect the supply of money in the country and its impact on GDP of Pakistan. Secondary resources data has been used in the research.

4.2 DATA SOURCE:
To check the effect on economic growth of Pakistan through monetary policy the data of different monetary variables like: inflation rate, money supply and interest rate from 1980 – 2016 has been collected. Secondary data is used in this study and State Bank of Pakistan is the main data source of data collection, other websites of Ministry Of Finance of Pakistan, Pakistan Statistics Bureau, web site of World Bank, the Global Economy and the international monetary fund website visited for the collection of data.
4.3 METHODOLOGY:
Sample Size: The study period consist data of previous 37 years from
(1980- 2016).

Variables: This study covers the estimation and analysis of data for the period 1980-2016 to check out the impact of monetary policy through inflation on growth rate of Pakistan.

Dependent Variable: Growth in GDP
Independent Variable: Interest Rate, Money Supply, Inflation
Variables in Detail:
Detail of each variable in the study is as under:
GDP Rate :
GDP is the dependent variable. GDP is the total market value of all final goods and services which produced in a country in a given year. The income, growth and output of the economy is measure by the GDP. The annual GDP rate of Pakistan in last years was very low because of high inflation rate. The GDP rate become increasing in 2014 because of good performance of government and industrial sector also by the integration of trade and finance sector. This increase in GDP raised the standard of living in Pakistan. This study shows the effect of GDP growth in the economy.

Money Supply:
The total amount of money circulate in economy at a particular period of time is the Money Supply in the country. The money supply become important in those country where money supply is attached with the economic growth. Publishing and recording of money supply is conducted by the government or by the central bank. Changes in money supply brings changes in the investment in the country. Financial sector focus changes in money supply because it directly effect price level, inflation rate and the business cycle in the economy.

Interest Rate:
It is the amount which is charged by a lender to a borrower for the use of assets. In monetary policy interest rates play a vital role as the investment and inflation rate is depends on interest rate. To increase investment in the economy interest rates reduced by the central bank. Interest rate adjust the inflation rate at that level which is suitable for economic activities. Low interest rate encourage people to borrow and saved money in banks on the other side high rate decrease the level of investment in the economy, this decrease in investment also decrease GDP rate. Interest rate is controlled by central bank through an effective monetary policy.

Inflation Rate:
Increase in price level of goods and services in an economy over a period of time is referred as inflation rate. Money supply and income is directly affected by inflation rate, excess supply of money create high rate of inflation in the economy that decrease the economic growth. The excess supply of money create positive relation with GDP rate in short run but in long run it generates inflation. High rate of inflation effect the purchasing power of the people, decrease the level of saving and investment. In 2009 Pakistan’s faces high rate of inflation.

4.4 STATISTICAL TEST:
Here we use E-Views software to check the data by using multiple regression model to find out the impact of money supply (M2, interest rate and inflation rate on the GDP of Pakistan. By:
Y = ?0 + ?1 X1 + ?2 X2 + ?3 X3 + ?i
Or
Y = ?0 + ?1 MS + ?2 IR + ?3 INF + ?i
Y Gross Domestic Product
MS Money Supply
IR Interest rate
INF Inflation rate
?i Error term
CHAPTER # 5
RESULT & DISCUSSION
5.1 INTRODUCTION:
Present study shows the connection between GDP and other variables as money supply, interest rate and inflation rate with monetary policy. This chapter covers the estimation and analysis of data for the period 1980-2016 to check out the impact of monetary policy through money supply, interest rate and inflation on growth rate of Pakistan. Main data source is State Bank of Pakistan moreover website of federal statistics bureau, IMF, global economy and world development indicator has been visited for this regard.

5.2 TESTING FOR STATIONARY:
The early and pioneering work on testing for a unit root in time series was done by David Dickey and Wayne Fuller (Dickey-Fuller test in 1979). The basic objective of the test is to test the null hypothesis that unit root is present in a time series sample. The augmented Dickey-Fuller (ADF) used in the test, is a negative number. The more negative it is, the stronger the rejection of the hypothesis that there is a unit root at some level of confidence. We have:
H0: series contains a unit root
vs. H1: series is stationary.
The decision rule here is if and only if the “P-value from ADF test > .05” then null (H0) is accepted. Otherwise the null hypothesis will be rejected.

We can see the result of ADF test in table 5.1 which indicate that some variables are stationary at level i.e. GDP and Money supply and some variables are stationary at first difference i.e. Interest rate and Inflation rate. As interest rate and inflation rate are stationary at first difference so we reject the null hypothesis of non-stationary and accepted H1 that is stationary.

Table 5.1: Result of Augmented Dicky-Fuller (ADF) test: Variables Test Statistics at Level Statistics at First Difference Order of Integration
Intercept Trend and Intercept Intercept Trend and Intercept GDP -3.60770*** -3.615803 Stationary at level
Money Supply -4.837052*** -4.762856 Stationary at level
Interest Rate -2.045583 -1.964635 -5.393834*** -5.328934 Stationary at 1st difference
Inflation Rate -5.048883*** -4.975654 Stationary at level
*** Shows significance level
Source: Author’s calculations using E-Views software
5.3 EMPRICAL RESULT:
Summary of statistics used in this study shown in table 5.2, the table shows that interest rate has lowest mean -0.07 and has lowest value of std. dev 1.74 on first level of difference. Money supply has largest mean 15.3 with largest value of std. dev 6.94 on level. The average of GDP is 4.75 where maximum growth rate is observed at 7.9 and minimum growth rate is 1.01, mean value of inflation is 9.29 with 24.8 maximum value and 0.4 minimum value.

Table 5.2: Summary of Statistics Used in Regression Analysis
GDP Money Supply (D)Interest Rate Inflation
Mean 4.756016 15.39262 -0.077222 9.295135
Median 4.846321 14.74655 -0.100000 8.370000
Maximum 7.920764 42.90887 4.130000 24.89000
Minimum 1.014396 4.314225 -3.390000 0.400000
Std. Dev 1.928868 6.949514 1.749169 5.247004
Probability 0.572763 0.000000 0.519398 0.007806
Observation 37 37 37 37
Source: Author’s calculations using E-Views software
Correlation shows the degree and type of relationship between two or more variables in which they vary together over a period of time, there may be positive or negative correlation between the variables. Result of correlation between the variables used in the study is shown in table 5.3. The result shows that money supply has positive relation with GDP rate while interest rate and inflation has negative relation with GDP. Increasing rate of interest rate and inflation has an inverse impact on the GDP rate while by increasing money supply increased GDP rate in the economy.
Table 5.3: Result of Correlation
GDP Money Supply Interest Rate Inflation
GDP 1.000000 Money Supply 0.253037 1.000000 (D) Interest Rate -0.088043 0.449064 1.000000 Inflation -0.411411 0.112445 0.365442 1.000000
Source: Author’s calculations using E-Views software
Taken GDP as dependent variable and money supply, interest rate and inflation as independent variable. Least square method is used in the data, total observations are 36 (after adjustment) and the data is taken from 1980 – 2016.
Table 5.4: Regression Analysis where GDP is a Dependent Variable
Variable Coefficient Std. Error t-Statistics Prob.

C 4.622916 0.962206 4.804497 0.0000
MONEYSUPP 0.090930 0.045511 1.997982 0.0543
INTEREST -0.094485 0.194890 -0.484813 0.6311
DINFLATION -0.147449 0.057605 -0.559645 0.0154
R-squared 0.265381 Adjusted R-squared 0.196511 S.E. of regression 1.684786 F-statistic 3.853338 Prob(F-statistic) 0.015421 Source: Author’s calculations using E-Views software
From the above estimation we find that interest rate has negative and significant impact on GDP. The value -0.09 of interest rate shows that by increasing 1 unit of interest rate GDP rate decreased by 9 units, if interest rate increased by adopting tight monetary policy it will negatively impact the GDP of the country in this Ho is rejecting. The value of inflation rate -0.14 shows negative and significant impact on GDP growth rate as 1 unit increased in inflation rate decreased 14 units of GDP rate.

Money supply with the value 0.0909 shows positive and significant impact on GDP rate of the country, 1 unit increased in money supply increased 9 units of GDP rate. Increased money supply leading to more consumption and more investment in the economy that raised the level of GDP so that we accepted H1. R-squared value 0.26 shows that 26% variation in GDP is explained by monetary variables (money supply, interest rate and inflation rate).
-155859137234900By adopting easy monetary policy SBP increased money supply that increased the GDP rate of the country, increased in money supply increased GDP growth rate. The trend of GDP rate and money supply is shown in fig 5.1, level of GDP rate decreased by decreasing money supply.

0216478200Trend between GDP rate and interest rate is shown in fig 5.2, increased interest rate in 1996 decreased GDP rate at the lowest point in 1993, maximum growth rate in GDP 7.3 is observed in 2003 when interest rate is 2.14. Increasing interest rate discourages firms and consumers from borrowing it become expensive to do so but on other hand it encourages to save more money in banks as they get more return. Because of less money to spent on goods and less investment in projects decreased GDP rate.

-47767105639400Increased money supply decreased interest rate which encourages consumers and firms for lending money and consumption. Firms and businessman borrow more money to invest in the country and common man start more consumption.

099568000Inflation is also negatively with GDP, increased inflation raised consumer spending and cost of production that increased the level of GDP in the country. (as shown in fig 5.4)
0161861500Inflation and money supply are negatively correlated to each other, more increase in money supply raised inflation level in the country. Pakistan sustained double digit inflation in 2000’s to control this SBP adopted tight policy and stable price level by increasing supply of general commodities.
CHAPTER # 6
Relation Of Monetary Policy With Its Variables
INTRODUCTION:
Monetary policy is an influential tool to attain main objectives for the development of the economy, it manage financial stability in the economy which is a key factor for long term economic growth. Sustainable economic growth as well as future expectation of economic activity is ensure by strong and efficient monetary policy. An effective monetary policy also play significant role in managing and sustaining financial stability in the economy that support stable inflation and low and stable prices that robust the economy.

MONETARY POLICY:
Monetary policy is a process in which government, central bank or monetary authorities of a country control money supply, availability of money and interest rate in order to attain set of objectives towards the growth and stability of economy. Government uses monetary policy as a key tool to influence the overall economic activity, monetary policy base on the relationship between interest rate (price at which money can borrowed) and supply of money in the economy. Monetary policy use variety of tools in order to control supply of money to get the outcomes like economic growth, unemployment, price stability and control inflation rate.
Monetary policy involves central banks to determine the interest rate and rate of growth of money supply in the economy with the objective to keep overall prices and financial markets stable and to maintain high rate of economic growth. Impact of an effective monetary policy regulate the flow of money in the economy to control inflation, low and stable inflation provide favorable conditions for sustainable growth in the economy. Monetary policy also have a strong impact on macroeconomics activity such as incomes, output level, employment, demand and supply of various goods and services.

Two different facet of monetary policy is adopted by central bank according to the economic condition that is either contractionary (tight) or expansionary (easy). In expansionary monetary policy central bank increased supply of money in order to reduce unemployment and decreased interest rate to boost private sector borrowing. On the other hand money supply is decreased in contractionary monetary policy in order to control inflation, increase unemployment and depress borrowing by private sector.

Table 6.1: Types of Monetary Policy
Expansionary Monetary Policy Contractionary Monetary Policy
Problem Unemployment ; Recession Inflation
Measures Federal reserve buys bonds, lower reserve ratio Federal reserve sells bonds, increase reserve ratio
Decrease interest rate Increase interest rate
Money supply increases Money supply decreases
Investment spending increases Investment spending decreases
Aggregate demand increases Aggregate demand decreased
Result Real GDP increases by increase in investment Inflation decreased

MONETARY POLICY IN PAKISTAN:
Pakistan’s monetary policy aims at stabilizing economic growth through number of channels, in Pakistan SBP has authority to conduct monetary policy and attain fuller utilization of economy’s productive resources. Monetary policy of Pakistan achieve the goal of promoting economic growth and price stability by targeting monetary aggregate in accordance with GDP growth and inflation targets set by the government. To generate economic activity in the country SBP concern with availability to private sector and adopt expansionary monetary policy to fulfill developmental need of a country.

SBP design its policy keeping in view SBP manage its monetary policy stance through adjustment in interest rate, changes in interest rate impact demand in the economy through several channels. Change in interest rate influence interbank market rate18 also borrowing cost for consumers and businesses as well as the rate on deposits for savers. It also impact people’s spending, wealth and financial assets, generally people save less and consume or invest more with lower interest rate. Adjustment in demand level affects the general price level and inflation in the economy.

To limit the inflation in the economy SBP designed contractionary policy in which SBP constrain supply of money and credit in the economy by increasing interest rate. On other side expansionary policy is a tool that SBP used to broaden money supply and credit in the economy by reduction in interest rate. SBP used money supply as a main instrument to control inflation within the targeted level set by government also growth in GDP rate.

VARIABLES OF MONETARY POLICY:
The main objective of monetary policy is to maintained price stability and promotes growth in the economy, monetary policy used some variables to achieve these objectives. The main variables are: GDP rate, money supply, interest rate and inflation rate. The relationship of these variables are explained as below.

GROSS DOMESTIC PRODUCT:
Gross Domestic Product (GDP) represent the market value of all goods and services produced in a country in specific period of time such as year, it is primary indicator used to show the economic growth of a country. GDP of a country can be obtained by summing up total consumption, investment in a country, expenditure made by government also total export of a country and minus the import of a country. Most commonly GDP can be measure by total income, output and growth of a country.

The growth momentum of GDP in Pakistan is measured by commodity producing sector (CPS) which include agriculture and industrial sector along with service sector, the most important component of CPS is agriculture sector that contributed large part of GDP in Pakistan. Majority of population of Pakistan directly or indirectly depends on income generated by agriculture sector. It gives a kick-start to aggregate demand for industrial goods and service sector. Second largest sector of economy is industrial sector and service sector is also play an important part in GDP growth.
Monetary policy directly link to the GDP rate of a country because increase in production increases income level of people and reduce unemployment in the country. Fluctuations has been seen in GDP rate of Pakistan since 1980, average growth rate is recorded during 1980’s due to macroeconomics instability. Low growth rate recorded through out 1990’s because of uncertain economic condition and political condition, GDP rate becomes better in late 1990’s after a period of low growth. Growth momentum of Pakistan’s economy shown in the start of 2000’s which is the result of better performance of CPS and services sector, contribution of CPS and service sector in GDP of Pakistan is shown in table 6.2.

Table 6.2: Sectoral Shares in Gross Domestic Product
(Percent)
Sector FY 80 FY 81 FY 82 FY 83 FY 84 FY 85 FY 86 FY 87 FY 88 FY 89 FY 90 FY 91 FY 92 FY 93 FY 94 FY 95 FY 96 FY 97
1. Agriculture (i to vi) 29.6 30.8 31.6 30.3 27.9 28.5 27.6 26.3 26.0 26.9 26.0 25.7 26.2 24.8 25.3 26.1 25.5 26.7
i. Major Crops 16.2 16.0 15.8 15.3 12.0 12.7 12.5 11.5 10.8 11.1 10.9 10.4 11.6 9.7 9.9 10.6 9.9 9.5
ii. Minor Crops 4.7 4.5 6.7 5.6 6.3 6.2 5.3 4.7 4.6 5.3 4.1 4.2 4.8 4.3 4.5 4.3 4.5 4.1
iii. Cotton Ginning – – – – – – – – – – – – – – – – – –
iv. Livestock 7.9 8.1 7.8 8.1 8.4 8.6 8.8 9.0 9.6 9.5 9.8 9.5 9.3 9.8 10.0 10.3 10.3 12.4
v. Fishing 0.5 1.1 1.0 0.9 0.9 0.8 0.8 0.8 0.7 0.8 0.8 0.7 0.7 0.8 0.7 0.6 0.6 0.6
vi. Forestry 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.2 0.2 0.2 0.2 0.2 0.2
2. Industrial Sector (i to iv) 24.8 22.6 22.3 22.1 22.7 22.5 23.3 24.0 24.4 23.9 25.2 25.8 25.4 25.3 24.9 24.8 24.2 23.5
i. Mining ; Quarrying 1.1 0.4 0.4 0.4 0.4 0.5 0.7 0.7 0.8 0.7 0.7 0.7 0.7 0.6 0.6 0.5 0.6 0.5
ii.Manufacturing (a + b + c) 15.8 15.1 15.1 15.3 16.1 15.9 16.3 16.7 16.8 16.6 17.4 17.5 17.3 17.3 17.5 16.3 16.0 15.9
Large Scale 11.5 11.1 11.3 11.4 12.2 11.7 11.8 12.0 12.2 11.8 12.3 12.4 12.1 11.8 12.2 12.0 11.7 11.5
Small scale 4.3 4.0 3.8 3.9 4.0 4.2 4.5 4.7 4.6 4.8 5.1 5.1 5.2 5.4 5.3 4.3 4.3 4.54
Slaughtering – – – – – – – – – – – – – – – – – –
iii.Construction 5.7 4.7 4.5 4.2 3.9 4.0 4.1 1.4 4.2 4.1 4.2 4.2 4.1 4.2 3.9 3.6 3.7 3.7
iv. Electricity ; Gas distribution 2.3 2.4 2.2 2.2 2.2 2.1 2.3 2.3 2.6 2.5 2.8 3.4 3.4 3.2 2.9 3.3 3.9 3.5
3. Service Sector (i to vi) 45.6 46.6 46.2 47.7 49.4 49.0 49.0 49.7 49.6 49.2 48.8 48.6 48.4 49.9 49.8 50.1 50.4 49.8
i. Transport, storage ; Communication 7.4 9.7 9.4 9.5 9.4 9.0 8.8 8.7 8.5 8.0 8.0 8.6 9.4 10.6 10.6 10.2 9.6 9.8
ii. Wholesale ; Retail trade 16.0 15.1 15.1 15.2 15.6 15.9 15.6 15.7 16.7 17.0 17.0 16.7 16.5 16.3 16.2 16.5 16.6 16.0
iii. Finance ; Insurance 2.5 2.2 2.5 2.9 3.2 3.1 3.2 3.2 3.1 2.9 2.8 3.0 2.8 3.0 3.3 3.4 3.4 3.6
iv. Ownership of Dwelling 3.4 4.5 4.5 4.8 5.0 5.1 5.0 4.9 4.6 4.4 4.5 4.4 4.3 4.5 4.4 4.3 4.3 4.3
v. Public Admin ; Defense 7.7 7.8 7.3 8.1 8.9 8.6 9.0 9.9 9.5 9.5 9.1 8.4 7.9 7.9 7.5 7.8 8.2 7.7
vi. Community Services 8.5 7.3 7.3 7.3 7.3 7.2 7.4 74 7.1 7.3 7.5 7.5 7.4 7.7 7.8 7.9 8.1 8.3
Source: Pakistan Bureau of Statistics
Table 6.2: Sectoral Shares in Gross Domestic Product
(Percent)
Sector FY 98 FY 99 FY 00 FY 01 FY 02 FY 03 FY 04 FY 05 FY 06 FY 07 FY 08 FY 09 FY 10 FY 11 FY 12 FY 13 FY 14 FY 15 FY 16
1. Agriculture (i to vi) 27.3 27.0 25.9 24.1 23.4 23.4 22.2 21.5 23.0 23.1 23.1 23.9 24.3 26.0 24.6 24.8 25.0 25.5 19.8
i. Major Crops 10.5 10.2 9.6 8.3 7.6 8.2 7.8 8.1 5.8 5.9 6.7 7.9 7.4 8.7 6.4 6.6 7.4 6.9 4.7
ii. Minor Crops 4.3 4.5 3.5 3.3 3.2 2.9 2.4 2.5 3.3 3.4 3.2 3.1 3.0 3.1 3.0 3.0 2.9 3.0 2.2
iii. Cotton Ginning – – – – – – – – 0.8 0.7 0.7 0.7 0.9 1.3 0.7 0.7 0.7 0.7 0.4
iv. Livestock 11.8 11.6 11.7 11.4 11.5 11.3 11.0 10.1 12.1 12.1 11.5 11.3 12.1 12.1 13.5 13.7 13.1 14.0 11.6
v. Fishing 0.5 0.6 0.4 0.4 0.4 0.4 0.3 0.3 0.6 0.5 0.5 0.4 0.5 0.4 0.3 0.3 0.3 0.4 0.4
vi. Forestry 0.1 0.1 0.7 0.7 0.6 0.6 0.6 0.4 0.5 0.5 0.5 0.5 0.5 0.5 0.6 0.6 0.6 0.6 0.4
2. Industrial Sector (i to iv) 23.8 23.7 23.3 24.0 23.9 23.9 27.0 27.1 21.0 21.1 22.3 20.2 20.6 21.2 22.1 21.0 20.9 19.0 20.9
i. Mining ; Quarrying 0.5 0.5 2.3 2.7 2.8 3.0 4.0 3.0 3.3 3.4 3.1 3.3 3.3 2.8 3.3 3.2 3.1 2.8 3.0
ii.Manufacturing (a + b + c) 15.8 15.5 14.7 15.5 15.5 16.0 17.2 18.6 13.8 14.0 15.2 13.4 13.6 14.3 14.5 14.1 13.9 12.4 13.4
Large Scale 11.5 11.2 9.5 10.5 10.2 10.6 11.8 13.3 11.7 11.9 13.2 11.4 1.5 12.2 12.2 11.7 11.5 9.8 10.7
Small scale 4.4 4.2 3.7 3.7 3.9 5.4 3.8 3.6 1.2 1.2 1.2 1.2 1.2 1.2 1.3 1.3 1.4 1.5 1.7
Slaughtering – – 1.5 1.4 1.4 – 1.5 1.6 0.9 0.9 0.8 0.8 0.9 1.0 1.1 1.1 1.1 1.1 0.9
iii. Construction 3.6 3.2 2.5 2.4 2.3 2.2 2.2 2.5 0.9 0.9 08 0.8 0.9 1.0 2.0 2.0 2.1 2.1 2.6
iv. Electricity ; Gas distribution 3.8 4.5 3.9 3.4 3.2 2.7 3.6 3.1 1.4 1.2 1.4 1.2 1.5 2.3 2.3 1.7 1.8 1.8 1.8
3. Service Sector (i to vi) 48.9 49.2 50.7 51.9 52.8 52.7 50.8 51.4 56.5 5.8 54.6 55.9 55.1 52.7 53.4 54.2 54.1 55.5 59.2
i. Transport, storage ; Communication 10.2 10.1 11.3 13.1 13.1 13.5 12.9 12.4 12.4 12.4 10.3 13.5 12.9 10.9 9.8 10.8 10.4 12.4 18.2
ii. Wholesale ; Retail trade 15.2 15.0 17.5 17.6 17.4 17.3 17.1 17.9 19.7 19.7 21.3 19.8 19.8 20.2 20.7 20.3 20.1 18.9 13.4
iii. Finance ; Insurance 3.1 3.2 3.7 3.0 3.4 3.2 3.1 3.1 3.7 3.9 3.9 3.8 3.3 3.0 3.0 2.4 2.5 2.4 3.2
iv. Ownership of Dwelling 4.4 4.5 3.1 3.2 3.0 3.0 2.8 2.7 6.5 6.4 6.2 5.6 5.5 5.0 5.1 5.1 5.1 5.3 6.7
v. Public Admin ; Defense 7.4 7.6 6.2 6.0 6.3 6.3 5.9 5.6 5.5 5.4 5.1 5.2 5.5 5.7 6.4 6.9 7.0 7.4 7.4
vi. Community Services 8.6 8.8 9.0 9.0 9.6 9.5 9.0 9.0 8.2 8.0 7.9 7.9 8.1 7.8 8.4 8.7 9.0 9.2 10.1
Source: Pakistan Bureau of Statistics
MONEY SUPPLY:
Money supply is total amount of money available in an economy at a specific period of time. Money supply is consider as main variable of monetary policy and play an effective part in GDP growth. Monetary policy ascertaining money supply to target interest rate and inflation for the promotion of economic growth because by increasing money supply, interest rates decreased and investment level in the economy will increased. The detail of money supply in Pakistan is shown in table 6.3.

SBP adjust money supply and interest rate in order to control inflation and price stability. SBP creates favorable environment for generating employment opportunities and sustained high growth in the country, extra amount of money spread in the economy by which consumer spend more money, industries increase production level by ordering more raw material. People borrow more money from banks to invest, business will flourish and employment opportunities increased in the country.
Table 6.3: Component of Monetary Assets
(Rs. Million)
Year Currency Issued Currency Held by SBP Currency in title of schedule banks Currency in circulation (1-2-3) Schedule banks total deposits (a) Other deposits with SBP (b) RFDC (c) Total Monetary Assets (4+5+6+7) Growth Rate
1 2 3 4 5 6 7 1980 30,236 400 2,187 27,649 64,124 651 – 92,424 7.57
1981 37,646 381 2,515 34,750 69,300 571 – 104,621 13.2
1982 40,689 374 2,665 37,650 78,256 604 – 116,510 11.3
1983 48,907 120 3,020 45,767 99,713 547 – 146,025 11.8
1984 55,440 397 3,004 52,039 110,529 699 – 163,267 12.6
1985 60,797 265 4,087 56,447 126,716 742 – 183,905 12.6
1986 67,804 427 4,101 63,276 146,957 878 – 211,111 14.8
1987 79,991 665 4,623 74,703 164,219 1,101 – 240,023 13.7
1988 93,432 518 5,135 87,785 180,341 1,218 – 269,344 12.2
1989 103,238 746 4,984 97,508 180,998 3,132 – 281,638 4.6
Table 6.3: Component of Monetary Assets
(Rs. Million)
Year Currency Issued Currency Held by SBP Currency in title of schedule banks Currency in circulation (1-2-3) Schedule banks total deposits (a) Other deposits with SBP (b) RFDC (c) Total Monetary Assets (4+5+6+7) Growth Rate
1 2 3 4 5 6 7 1990 120,818 399 5,531 115,068 199,945 2,209 – 317,222 12.6
1991 144,916 610 7,333 136,967 219,215 3,114 9,487 368,783 16.3
1992 161,433 652 8,962 151,819 282,399 3,322 43,004 480,544 30.3
1993 178,933 768 11,301 166,864 334,582 4,449 61,274 567,169 18.0
1994 199,070 624 13,738 184,708 380,457 5,506 92,134 662,805 16.9
1995 232,589 647 16,363 215,579 447,291 5,055 105,073 772,998 16.6
1996 253,908 470 19,328 234,110 451,821 6,791 145,958 938,680 13.8
1997 262,589 627 17,821 244,141 579,076 7,135 222,882 1,053,234 12.2
1998 293,263 1,572 18,769 272,922 648,430 6,412 278,556 1,206,320 14.5
1999 308,542 1,955 18,870 287,717 865,701 6,212 120,917 1,280,547 6.2
2000 376,997 1,851 19,468 355,677 924,521 7,959 112,475 1,400,632 9.4
2001 396,548 1,905 19,178 375,465 985,133 11,292 154,154 1,526,044 9.0
2002 462,095 1,865 26,414 433,816 1,156,251 13,847 157,456 1,761,370 15.4
2003 527,557 2,565 30,415 494,577 1,454,491 3,499 126,138 2,078,705 18.0
2004 617,508 2,960 36,432 578,116 1,760,630 2,116 145,694 2,486,556 19.6
2005 712,480 3,107 43,472 665,901 2,116,821 3,335 180,295 2,966,352 19.3
2006 791,834 3,005 48,439 740,390 2,661,584 4,931 195,501 3,406,405 15.1
2007 901,401 3,148 58,072 840,181 3,217,962 7,012 207,312 4065,155 19.3
2008 1,054,191 2,900 68,966 982,325 3,702,566 4,261 263,430 4,689,143 15.3
2009 1,231,871 2,693 77,006 1,152,173 3,980,384 4,662 280,364 5,137,219 9.6
2010 1,385,548 2,491 87,673 1,295,385 4,475,186 6,663 345,438 5,777,234 12.5
2011 1,608,641 2,380 104,852 1,501,409 5,183,640 10,145 374,945 6,695,194 15.9
2012 1,785,775 1,974 110,055 1,673,746 5,959,150 8,899 440,130 7,641,795 14.1
2013 2,050,157 1,068 110,867 1,938,222 6,909,066 9,075 514,988 8,856,364 15.1
2014 2,317,891 529 139,490 2,177,873 7,777,021 11,689 599,384 9,966,583 12.5
2015 2,715,556 208 160,299 2,554,749 8,713,648 13,747 597,760 11,282,144 13.2
2016 3,563,749 634 229,331 3,333,784 9,472,313 18,756 587,258 12,824,853 13.7
a : Excluding interbank deposit of federal ; provincial government ; foreign constituents.

b : Excluding counter part funds, deposits of foreign central bank, foreign government ; international constituents / organizations.

c : The data on Resident Foreign Currency Deposit (RFDC) account (allowed to be opened by residents of Pakistan as from 23-2-91) have been included as part of monetary assets knocking them off as foreign liability.

Source: Pakistan Bureau of Statistics
INTEREST RATE:
Interest rate is the amount by which people borrow or lend money from banks and other financial institute. Increase and decreased in interest rate changes the pattern of economic activities, increased in interest rate reduce investment level in the country. Decreased interest rate is best for economic condition as people can borrow money to invest, consumption level of people increased and growth is shown in the economy. Low interest rate provide investor better opportunity to invest more in the business and heavy investment also shown by firms to produce heavy revenue.

INFLATION:
Inflation is key indicator of a country, it’s a situation when prices of general goods and services rises and purchasing power of people fall. Strong relation exists between inflation and GDP rate, high level as well as low level of inflation are harmful for the economy. High level of inflation raises the prices of general commodities that directly affect the low income people of the country on the other hand low level of inflation negatively effect the growth level of the country as the assets prices come down and demand of money become slow.

Inflation is caused by increase in money supply in the economy because too much supply of money decreased the value of money that result increased in prices of goods. Inflation can measured by percentage change in average level of prices and in Pakistan main focus is placed on CPI as a measure of inflation. Excessive supply of money increase inflation level by which investment level in the country comes down resulted decreased in GDP growth of the country,
CONCLUSION:
From the study we conclude that monetary policy has strong impact on economic growth and selection of monetary policy depends on the variables of monetary policy. The frame work of monetary policy in Pakistan is set by State Bank of Pakistan. Economy of Pakistan is directly effected by excessive money supply which resulted high rate of inflation and decreased the growth level. Significant relation is present between GDP and money supply as and increased in GDP rate is shown by increasing money supply. Where as GDP and money supply is negatively related with interest rate, increasing interest rate decreased money supply and GDP rate of the country. SBP needs to control money supply to boost the economy, stabilize the prices and to control inflation in the country.

REFRENCES:
Abdul Qayyum. (2002). Monetary Condition Index: A Composite Measure of
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Hafeez, R., & Imtiaz A. (2002). Impact of Monetary Policy on Monetary Assets in Pakistan
Hameed G., et all. (2012). Linkage between Monetary Instrument & Economic Growth
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Irfan H., & Amen Ume. (2011). Impact of Monetary Policy on Gross Domestic Product (GDP).

M. Kamran, et all. (2014). Exploring the Impact of Macro Economics Variable On GDP Growth of Pakistan.

Bojan & Lovre. (2012). Essay on Monetary Policy & Economic Growth
Imran, S.Ch., Ruqia, I., Fatima Farooq & G. Murtaza. (2015). Monetary Policy & its Inflationary Pressure in Pakistan
Iqra Ihsan & Saleem Anjum. (2013). Impact of Money Supply (M2) on GDP of Pakistan.

Mahmood, H., & Fida Hussain. (2005). Monetary Aggregates in Pakistan.

Kalbe, A., & M. A. Qasim. (1993). An Analysis of Monetary Policy in controlling
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M. Ayyoub, Imran, S. Ch., & Fatima Farooq. (2011). Does Inflation affect Economic Growth: The Case of Pakistan.

Ahmed M. Khalid. (2005). Economic Growth, Inflation & Monetary Policy in Pakistan: Preliminary Empirical Estimates.

M. Azhar, K., & Sonia, H., (2014). Effectiveness of Monetary Policy in Controlling Inflation in Pakistan.

Abdul Qayyum (2006). Money, Inflation, & Growth in Pakistan.

Abid Rashid Gill. (2010). Determinants Of Velocity Of Money In Pakistan.

WEB SITE REFRENCES:

http://www.pbs.gov.pkhttp://www.sbp.org.pkhttps://www.theglobaleconomy.comhttps://data.worldbank.orghttp://data.imf.orghttp://www.academia.eduhttp://www.finance.gov.pk

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