Monetary Policy -- All Greek to me

Monetary policy has traditionally been viewed as the process by which a central bank uses its influence over the supply of money to promote its economic objectives. In fact, the very term monetary policy suggests a central bank’s policy toward the supply of money or the level of some monetary aggregate.

In Pakistan, the central bank is injecting Rs.20-25 billion average daily. Banks lent this amount to government through T-bills, PIBs and even government sectors enterprises TFC (circular debt Rs.85bn). Before this setup, government used to borrow from SBP, which, according to SBP increases reserves money and eventually fuel inflation. The notion behind introducing the market base facility is to control money supply. As higher borrowing would increase cost and thus correct the imbalance. In some cases, it was achieved by increase reserve requirements. Though surprisingly, rumors are that the central bank is about to cut not only its policy rate but reserve requirement as well.

This will affect money supply and indeed future inflation outlook. Well, SBP is an independent institution, if it feels that in order to achieve it yearly inflation and growth targets the measure is necessary than fine they should do it. But history suggests otherwise, for example, I could not find a year in which, SBP achieved its inflation target indeed our history is full of monetary overhang. They set targets and miss them and the parliament is quite on that. Recently, in New Zealand the central bank chief had to resign as he miss his inflation target in a few decimals, we miss it by 100% margins.

In US the central bank chief has to testify to the senate about his decisions. Our central bank head has no such obligation(s).

In its last monetary policy decision, the central bank had introduced, interest rate corridor, the floor is paying 10% interest on excess reserves. Way back in 2006, when Fed wanted to introduce the corridor, It was understood than law does not permits Fed to pay interest on deposit and thus it was delayed and will be introduce in 2011. What about us?

If price stability is SBP’s prime job (indeed, growth complete the dual mandate) then the question is SBP performing his duties? Or the measure it is taking would help serve the national objective?