shamshad akhtar : monetary policy in pakistan speech by dr shamshad akhtar, governor of the state bank of pakistan, at the federation of pakistan chambers of commerce & industry, karachi, 30 april 2007. * * * mr. tanvir ahmed sheikh, president fpcci, mr. zubair tufail, vice president fpcci and mr. sheikh amjad rasheed, chairman fpcci committee on banking, credit, & finance background monetary policy management and financial sector stability are two primary roles of state bank of pakistan ( sbp ). monetary policy and process of its formulation in pakistan has undergone changes with the evolving economic dynamics within the country and the improved empirical and theoretical understanding of the monetary policy across the world. monetary policy in pakistan, in line with sbp act, has been supportive of the dual objective of promoting economic growth and price stability. it achieves this goal by targeting monetary aggregates ( broad money supply growth as an intermediate target and reserve money as an operational target ) in accordance with real gdp growth and inflation targets set by the government. over the years, while maintaining the broad legal mandate, sbp has improved the quality of monetary formulation and its process quite significantly. this morning, i propose to first outline measures taken by the government and sbp to strengthen the monetary policy management. second, i will discuss the rationale and key elements of sbp current monetary policy stance which i believe is helping bring down inflation without stifling credit or economic growth. finally, i will discuss the impact of sbp ’ s policy actions, and challenges in its implementation. changes in monetary policy management sbp shifted its reliance from an administered monetary policy regime governed by ad hoc changes in reserve ratio ’ s, directed credit and regulated interest rate policies in mid 1990s to a liberal and market oriented monetary policy management. abolishing sector and bank credit limits, central bank adopted “ 3 - day sbp discount rate ” as a major policy instrument to signal easing or tightening of monetary policy which essentially responded to the demand pressures of the economy in line with the growth trends in monetary liabilities and monetary assets – with former capturing the growth in currency and deposit base and latter the growth in domestic credit ( including both government borrowings and private sector credit ). generally monetary module of the economy is the least understood area. this is largely because monetary segment of the economy deals with on one hand the changes in stocks and flows of money supply and on the other hand

crs ) for banks which helps in assessing the market liquidity. sbp ’ s treasury operations and gradual improvements in its liquidity management have together helped omos and money market development. current monetary policy stance public, businesses and market needs to develop understanding that monetary policy does indeed, over the long run, determine the behavior of the price level. while inflation is precipitated by supply shocks, hoarding, official restrictions, import prices, and so on, but these influence price level in a given year. however, it is monetary policy that can prevent an effect on the rate of inflation over a more extended period. that is, following the initial price level shock, an appropriate adjustment of the interest rate ( if necessary ) can stop a potential second round of repercussions on wages and prices. specialists use measures of core inflation, which exclude volatile prices, as a way to see through oneoff shocks. core inflation is very useful to the central bank itself, as a guide to the appropriate setting of its monetary policy stance. unexpectedly low ( high ) core inflation usually indicates the need for easing ( tightening ) in the policy stance. the ultimate objective of a central bank, and the measure of success of its policy, is in terms of overall ( i. e. headline ) inflation. in this context, the way to deal with price level shocks is to stress their temporary nature with respect to the inflation rate. this involves : ensuring that the effect on inflation is only temporary – this may or may not require a policy action, and realizing that as monetary policy influences the trend of prices with a lag of at least a year and a half, headline inflation should return to its pre - shock rate not within not 1 year but 2 years. price signals in a market economy operate less effectively when the price level is unstable ; in addition, resources are diverted to unproductive speculation and hedging. thus, countries with unstable price levels – high inflation or deflation – almost always experience weak output and growth. thus, low inflation is not merely an end in itself, but also a means to good overall economic performance. the main cause of high interest rates is high inflation, through the expected - inflation premium. conversely, the best prospect for low interest rates is a stable environment of low inflation. in this context, the relatively high interest rates that may be necessary to achieve a desired disinflation represent “ short - term pain for long - term gain ”. sbp,