Understanding Monetary Policy

In recent years it has been observed that many people within the economy and specifically in
financial sector wait for the next monetary policy for making decisions.
However monetary policy has now been reduced to merely interest rate regulation, closely tied to
the discount rates offered on Treasury Bills. Monetary Policy however has three main components.
Academically speaking, monetary policy in Pakistan's case would be steps taken by the Central
Bank to target an inflation rate that would be required by Price stability in the market. Astonishing!
As many of you were told otherwise, primarily regarding trade offs between economic growth,
interest rates and money supply. They all form part of the monetary policy but the main objective is
to attain an acceptable inflation rate.
In this article an effort has been made to simplify the monetary policy as such this may not be
considered an academic discussion from this point.
Monetary policy has three tools; 1) OMO (Open Market Operations), 2) Interest rate regulation and
3) Reserve regulation.
Firstly Open Market Operation or OMO as they are usually referred is the buying and selling of
Government Papers in order to regulate money supply. It is common to hear of so many billions
wiped off from the market using OMO or so many more brought into the system, the system of
course is the banking system. This ofcourse effect the interest rate of interbank borrowing.
Secondly Interest rate regulation is used in our scenario, because of its relative simplicity. The State
Bank fixes a rate of borrowing and thus it forms a basis for lending throughout the system. It is the
most discussed in our monetary policy in fact for long I have seen that it is the only one.
Lastly its the reserve regulation that primarily there for protecting the account holders and the bank
in case there is an extraordinary withdrawal and the bank has no funds, it must have enough
reserves to face such a situation. There are many aspects to this tool in monetary policy. It can also
be used to control the amount of money available in the market for lending and also to protect the
system.
The interesting thing here is that even many seasoned bankers would have just recalled this after a
long time. It has never been brought up. But what is a monetary policy without the use of these
effective steps. There are many reasons why this has never been brought up in recent times.
We have seen that for the past many years now that banks have reduced their lending to the private
sector and increased their investments in treasury papers. As such the monetary has been reduced to
a mere statement of the interest rate every eight weeks. It may have made the regulators work a lot
easier that now it just has give a policy rate and has nothing else to do. If it does perhaps it is not
willing to share.
Banking is an elaborate industry, it needs regulation even in a free market economy according to
many. So would readers agree that the two main tools of monetary policy be not used. They must be
used, but to effectively support and encourage economic activity.