Monetary policy

Topics: Inflation, Monetary policy, Money supply Pages: 9 (2586 words) Published: March 25, 2014
Effects of Monetary Policy on Economic Variables

Department of Economics
Submitted to Ma’am Rumana

The study investigates the effects of Monetary policy on some significant economic variables like exchange rate, gross domestic product and inflation using data from 1960-2010 to analyze the results. We have taken the data in percentage form. A great number of empirical studies on the relationships of monetary policy and inflation are available and most of these have analyzed the effectiveness of monetary policy in controlling inflation in Pakistan. In this paper we have presented the effectiveness of monetary policy it’s framework and data estimation through which we reached to the conclusion that monetary shocks do affect real variables like GDP, inflation and exchange rate. Pakistan has been estimated by a number of researchers and it has been recognized that monetary phenomenon are responsible for the high levels of inflation. Keywords: Monetary Policy, Inflation, Exchange rate, Economic Growth, Gross domestic product and Pakistan. Introduction

This paper attempts to examine the long-run effects of Monetary Policy on several economic variables such as inflation, economic growth that is gross domestic product and exchange rate in Pakistan. For this purpose, analysis have been employed for the period 1960-2010. As monetary policy actions affect policy variables with a significant gap and with high degree of unpredictability and insecurity, it is key to predict the probable impact and degree of monetary policy actions on the real variables. Usually, policy makers and central banks decide that price stability or low inflation would prompt higher economic growth. Commonly, historical indication does reveal that Pakistan has been a high inflation and high interest economy given its natural structural flaws. The part and effectiveness of monetary policy appears more evident in the 2000s when financial sector reforms started manner fruits in terms of a more market based money and foreign exchange markets. in the period 2001–2005, monetary policy of the SBP was biased towards supporting growth because of its expectation that inflation could be maintained at low levels while giving the economy a monetary stimulus. In keeping with monetary experience, inflation started accelerating in 2005, forcing a reversal. To control inflation, monetary authorities in Pakistan use M2 as an intermediate target. Growth of this monetary aggregate is fixed annually, and was maintained within target till 2001. From 2001 to 2005 the actual money supply growth was overshot by 69 percent on average from the targeted money supply growth. The prime objective of the second paper “Money, Inflation, and Growth” by Abdul Qayyum, is to test the validity of the monetarist stance that inflation is a monetary phenomenon, i.e., the money supply growth (excess) causes inflation in Pakistan. The study shows that money (M2) growth remains above the target level since 2001 and inflation exceeds its target during 2005 and 2006. The velocity of money shows a decreasing trend over the period from 1973 to 2005. During 2005, inflation tax on money holder is estimated to be 0.98 percent of GDP. Finally, the study concludes that there is proportional relationship between the excess money supply over the output growth and the velocity growth. It implies that excess money supply is the main cause of inflation in Pakistan. The important policy implication is that inflation in Pakistan can be cured by sufficiently tight monetary policy. The creation of monetary policy must consider development in the real and financial sectors and treat them as constraints on the policy. After remaining relatively low for quite a long period of time, the rate of inflation speeded in Pakistan starting in late 2003. Following the 1998-99 crisis, inflation was reduced to below 5 percent by...
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