AN EVALUATION OF IMPACT OF MONETARY POLICY ON ECONOMY OF PAKISTAN

Abstract

Objective of the study is to evaluate the impact of monetary policy on the economy of Pakistan in the light of Monetarist and Keynesian views. Keynesian argue that monetary policy is ineffective in stimulating the economic growth of a country, which is said to be determined by the economic growth levels of its large and developed trading partners. Money supply and inflation are considered to be insignificantly related to economic growth. It is further argued that the monetary authorities cannot control money supply changes as desired, namely, to keep them within the set money supply guidelines, because of foreign external forces flowing out of international trade conducted with these large and developed partners. By contrast, the monetarist counter-argument affirms the efficacy of the money supply and inflation in influencing the economic growth of a country. Monetary authorities are said to be capable of controlling money supply via the bank rate (repo rate), that the current level of money supply is significantly related to that of the previous period. By using forty year data, it is evaluated that impact of interest rate on economic growth is negative and at the same time its impact on unemployment is positive. It is also investigated that there exist tradeoff between inflation and unemployment. It is also estimated that current money supply strongly depends upon the money supply of previous period. Impact of monetary base and broad money on economic growth and on unemployment is very much weak near to zero. Saving is the component of aggregate savings and consumption is the necessary component of aggregate demand but it is evaluated that impact of saving on GDP growth rate is significantly positive as compare to consumption. So those policies should be used which are helpful to increase the saving in the xiv country. In the case study of Pakistan, the empirical findings confirm that the economic growth is not significantly related to changes in money supply and inflation but it is significantly related to the changes in real exchange rate and interest rate and that ability of monetary authorities to control money supply is constrained by external factors. While monetary policy is ineffective in controlling changes in the money supply, keeping it within set target limits or guidelines, it is able to influence the current level money supply by operating on that of the previous period.The Keynesian argument that the monetary authorities cannot control money supply changes, i.e. keeping them within set target guidelines, is confirmed. The basis of this argument is said to be the unfair terms of trade faced in dealing with large and developed countries. This is despite the significant relationship between the current level of money supply and that of the previous period.