Monetary Policy in Pakistan

If the velocity has a little change by the money supply then nominal GNP would be lower than the actual as in 1986 same time the price level was less than the current, the employment and real output have been smaller than the previously fourth. Hamburger’s demand for money equation shows that the money demand slowly adjusts to its final determinant. The slow adjustment in recession of money supply declines the velocity. On the other hand an increase in interest with the reduction of M1 would be expected to increase the velocity. The IS-LM model establishes the elasticity the saving with respect to income and investment with respect to interest. The system needs the monetary policies for economic stabilization. Optimal monetary policy set the money supply’s growth at a fixed

Furthermore, when the government borrows all this money another problem is created called “crowding out.” The interest rates are increased because of the deficit spending from the borrowing. Hence, the financing needed by private businesses is more difficult as well as the purchasing of new equipment or construction of new factories. Government borrowing deteriorates the strength of the economy as well as builds debt. Private spending decreases when government spending increases. Stimulation from government into the economy should only occur once it has been given a chance to recover on its own and failed.

There are two ways the economy can be assisted in growing and sustaining itself. First through fiscal policy from the national governments help of changing taxes and spending, then Monetary policy, the managing of money. The two are supposed to work together to help create a better economy but, at times fall short. Leaders in the government for the most part have a top priority to stay in their position, with that in mind they tend to give the people the immediate satisfaction they want which is increased spending and reduced taxes. With this approach fiscal policy is considered expansionary, restrictive monetary policy is what is needed to stop inflation to counteract this.

Targeting interest rates that can directly control inflation. The monetary policy is one that quickly comes into play. Central banks are independent of the government and refrain from political influence. They can boost exports by merely weakening the currency. The benefits of the fiscal policy consist of direct spending to specific purposes, by using taxation they can discourage negative externalities, and have a shorter time lag. The potential costs of the policies can create budget deficits, having to spend tax incentives on imports, and may be motivated by politics.The use of the monetary policy runs the risk of hyperinflation, the time it takes for the effects to materialize, the technical limitations and the fact that financial tools affect the entire

Fiscal sustainability is another public policy goal to overburden monetary policy. The gross and net debt/GDP ratios in the United States, the United Kingdom, the euro area and Japan show these four economies face the fiscal challenges. But there is larger problem which the governments have not yet change their spending and taxing. The political inconformity cause they are difficult to accept a sensible long run plan which can make the long run fiscal sustainability and short run growth at same time. So in this condition, many governments

While it is true that the use of macroeconomic have declined in the twenty-first century, nevertheless, the governments’ policies are still effectives and have assisted in promoting economic growth. Fiscal policies and monetary policies are two of the ways the states manage the national economy (Barma and Vogel, p. 540). Through the fiscal policies, which consists of the taxation and government expenditure, the federal government is able to positively or negatively affect economic activities, and also be able to stimulate certain sectors of the market (Barma and Vogel, p. 540). While strict restriction on monetary policies, particularly the flow of capitals can affect the level of trade and foreign investments in a nation, states are still capable of controlling such economic activities through their

The Federal Government uses the monetary policy and fiscal policy to establish and determine the best way to manage the economy. Monetary policy is used by the Federal Reserve to manage the money supply. This includes credit, cash, check, and money market mutual funds, with loans, bonds, and mortgages being the most important. This policy can be broken into two categories: monetary restraint and monetary expansion. As it states, one is trying to restrain the market while the other expresses expanding the market. With control over the money supply, the two categories for monetary policy can manage the inflation of the economy. After this has been complete, the unemployment rate is a second objective that is handled and reduced. Fiscal policy is used as reference to the tax and spending policies, and is handled completely by the Federal Government rather than the independent agency of the Federal Reserve. In comparison to the monetary policy, there is also two sub categories of expansion and restriction. This paper will explain why I believe the monetary restraint policy is the best option for maintaining a stable economy through the use of controlled spending by limiting the access consumers have to money, its reliability in being the solution to a growing problem, and the benefits we see from past occasions. Using the monetary restraint policy will require the Federal Reserve to increase the interest rate nation-wide requiring citizens to decrease spending and borrowing.

However in the event that the government endeavored to unravel the monetary allowance deficiency by expanding the rate of charges this would further flatten the economy prompting lower development and more unemployment. On the off chance that there is a negative multiplier impact this may really bring about the deficiency to expand significantly more. It is viewed as one of the positives of shortfall spending. “When a government spends excessively, it can afford to buy infrastructure for the country. This, in turn, leads to employment of labor force. As more money flows into the country, the overall economy growth rate accelerates” (Advantages and Disadvantages 2014). This is particularly helpful amid a retreat, as this can animate employments, expand organizations, private speculation endeavors increment, and thus, the country's economy

However, because of the plentiful unused productive resources and low interest rate during the financial crisis, increasing government spending both decreased the unemployment rate and increased output. As shown in Figure 4, since the U.S. economy was characterized by a significant shortage in demand and excess in capacity, like point A and B inside the production possibility frontier, increasing government spending shifted these points out toward point C rather than just moving these points along the same curve. Thus, moving outward resulted in increases in both the amount of output and the employment rate. In addition, since the financial market fell into a liquidity trap during the financial crisis, increasing government spending did not result in an extremely high interest rate, which might cause inflation and threaten the total amount of investment inflation. On the other hand, even if the interest rate is higher than expected, the Federal Reserve could use expansionary monetary policy to decrease the interest rate through open market

Naturally, during an inflationary period it becomes very difficult for the government to fulfill its macroeconomic targets. Almost all targets, such as GDP growth, price inflation, bank borrowing, trade deficit, budget deficit, become difficult to achieve. This questions the credibility of the government. Costs of development project and non-development expenditure increase, due to which the government needs more funds the following year by the amount of inflation to keep economic activity at the level of the former year.

Author John Hilsenrath points out that United States and United Kingdom have taken aggressive monetary policies in order to restore its financial health and appeared to heading the correct direction. By embracing monetary expansion, central banks purchase Government bonds so the supply of money increases. Due to excess supply of money, people buy bonds and in turn raising the prices of bonds. The higher the bond price, the lower the interest rate. With this lower interest

There was not much scope for monetary policy making in the RBI during the period 1935-51. At this time monetary expansion was restrained reflecting low levels of economic activity, with a pegged foreign exchange rate presenting a major challenge to monetary management. In the war and post-war years, the focus of monetary policy shifted to managing inflation and through providing interest rate signals by controlling yields on Government paper, as the Bank Rate remained fixed after a one-time reduction from 3.5 per cent to 3.0 per cent in 1935.

But in a severe recession, such as in 2008-2009, the government resorted to increased spending, in order to get these times out of decrease and into economic increase. Another type of fiscal policy is aimed to create more expansions and fewer recessions in our economy. This is knows as the nondiscretionary fiscal policy, or automatic stabilizers. The main source of the federal money brought in is from progressive income tax, which aims to increase demand in a recession and decrease demand in an expansion, along with the welfare system. In the 2008-2009 recession, these automatic stabilizers made a much bigger stimulus than the changes made to taxes and spending by the government. When it comes to the monetary policy, the promoting of the economic growth comes from the Federal Reserve System. In order to make growth during a recession, the bank lowers interest rates and increase money supply. In an expansion, the opposite occurs, where the interest rates are increased but the money supply is decreased. This impact though can take several months for it to change the demand. An issue with this though is the fact that the bank is not controlled by the president or congress, but could be seen as a positive compared to the fiscal policy, which has to be overseen by both the president and congress.

This essay seeks to explain what are monetary and fiscal policy and their roles and contribution to the economy. This includes the role of the government in regulating the economical performance of a country. It also explains the different features and tools of monetary and fiscal policy and their performance when applied to the third world countries with a huge informal sector.

A combination of fiscal and monetary policy is generally used to steer the economy in a desired direction. Although governments direct fiscal policy, many countries delegate responsibility for monetary policy to central banks. This strategy prevents governments from manipulating interest rates for short term political advantage and promotes stability in the money supply as well as in the price of goods.