. in this backdrop, there is no surprise that most of the central banks aim at maintaining low and stable inflation. central banks place more weight and demonstrate increased willingness on controlling inflation relative to output growth, and financial and exchange rate stability. it is important to acknowledge, however, that in practical policy making, adhering to revealed preferences is rather difficult. the reason is that central banks do not operate in a vacuum and require coordination with other policy making institutions, in particular the fiscal authority. in addition, the social and cultural make - up of a country and political economy considerations often require central banks to accommodate conflicting policies. in other words, sticking to an announced rule - based monetary policy can be difficult in practice ; “ enlightened discretion ” is preferred by most central banks. thus, sbp ’ s decision to focus on arresting the persistent inflationary trends is tantamount to a pro - growth policy, not a growth retarding one. c. monetary policy transmission mechanism the monetary transmission mechanism refers to a process through which monetary policy decisions affect the level of economic activity in the economy and the inflation rate. understanding the transmission mechanism of monetary policy is crucial for appropriate design and efficient conduct of monetary policy. as monetary policy actions affect policy variables with a considerable lag and with high degree of variability and uncertainty, it is important to predict the possible impact and extent of monetary policy actions on the real variables. thus, by its very nature, monetary policy tends to be forward - looking. it is also important to know which transmission channels are more effective in terms of transmitting changes in monetary policy actions to ultimate policy goals. since various financial sector developments particularly regarding introduction of new financial products, technological changes, institutional strengthening, and expectations about future policy, etc. http : / / www. federalreserve. gov / newsevents / speech / bernanke2006. 02. 24a. htm # f3 # mainnav can potentially change economic effects of the monetary policy measures, there is a need to regularly update, empirically test and reinterpret monetary policy transmission channels. the impact of monetary policy is perceived to transmit in to the real economic activity through five channels. • the first channel and most widely studied and understood channel of monetary policy transmission relies on the link between changes in the short - term nominal interest rate ( induced by changes in the policy rate ) and the long - term real interest rate that ultimately affect components of aggregate demand such as consumption and investment in

demand - side inflationary pressures were strong. in this perspective, sbp further tightened its monetary policy in july 2006 raising the crr and slr for the scheduled banks ; and its policy rate by 50 basis points ( bps ) to 9. 5 percent. moreover, proactive liquidity management helped in transmitting the monetary tightening signals to key interest rates in the economy. for instance, the karachi inter bank offer rate ( kibor ) of 6 month tenor increased from 9. 6 percent in june 2006 to 10. 02 percent at end - june 2007 and the banks ’ weighted average lending and deposits rates ( on outstanding amount ) increased by 0. 93 percentage points and 1. 1 percentage points, respectively, during fy07. in retrospect, it appears evident that monetary tightening in fy07 did not put any adverse impact on economic growth, as not only was the real gdp growth target of 7. 0 percent for fy07 was met, the growth was quite broad based. at the same time, the impact of the monetary tightening was most evident in the continued deceleration in core inflation during changes in annual average food price index ; source : imf commodity price data. fy07. one measure of core inflation, the non - food non - energy cpi, continued its downtrend from yoy high of 7. 8 percent in october 2005, to 6. 3 percent at end - fy06, and to 5. 1 percent by the end of fy07. however, much of the gains from the tight monetary policy on overall cpi inflation were offset by the unexpected rise in food inflation. on the downside, however, broad money supply ( m2 ) grew by 19. 3 percent during fy07, exceeding the annual target by 5. 8 percentage points. slippages in money supply growth largely stemmed from an expansion in nfa due to the higher than expected foreign exchange inflows. equally stressful was the impact of government borrowings from the central bank during the course of the year. the pressure from the fiscal account was due to mismatch in its external budgetary inflows and expenditures. with the privatization inflows and the receipts from a sovereign debt offering at end - fy07, the government managed to end the year with retirement of central bank borrowings, on the margin. by end - fy07, sbp holdings of government papers were still around rs