About Monetary Policy

Monetary policy involves central banks’ use of instruments to influence interest rates and/or
money supply in the economy with the objective to keep overall prices and financial markets
stable. Monetary policy is essentially a stabilization or demand management policy that
cannot impact long-term growth potential of an economy. Preamble to SBP Act, 1956
envisages monetary policy to secure monetary stability and attain fuller utilization of
economy’s productive resources. In SBP’s view, the best way to achieve these objectives on a
sustainable basis is to keep inflation low and stable.

Low and stable inflation provides favorable conditions for sustainable growth and employment
generation over time. It reduces uncertainties about future prices of goods and services and
helps households and businesses to make economically important decisions such as
consumption, savings and investments with more confidence. This, in turn, facilitates higher
growth and creates employment opportunities over the medium term leading to overall
economic well-being in the country.

In practice, SBP’s monetary policy strives to strike a balance among multiple and often
competing considerations. These include: controlling inflation, ensuring payment system and
financial stability, preserving foreign exchange reserves, and supporting private investment.

How does Monetary Policy Work?

SBP signals its monetary policy stance through adjustments in the policy rate; that is, the
SBP Target Rate for the overnight money market repo rate. Changes in the policy rate impact
demand in the economy through several channels and with a lag. In the first place, changes
in policy rate influence the interest rates determined in the interbank market at which
financial institutions lend or borrow from each other. The market interest rates are also
influenced by central bank interventions in money and foreign exchange markets as well as
by its communication.

The changes in market interest rates influence the borrowing cost for consumers and
businesses as well as the return on deposits for the savers. Generally, lower interest rates
encourage people to save less and consume/invest more, and vice versa. Changes in the
policy rate also influence the value of financial and real assets, impacting people’s wealth and
thus their spending. The adjustment in demand finally affects the general price level and thus
inflation in the economy.

Monetary Policy Framework

Monetary Policy Objectives

The preamble of the SBP Act, 1956 envisages these objectives as ‘whereas it is necessary to
provide for the constitution of a State Bank to regulate the monetary and credit system of
Pakistan and to foster its growth in the best national interest with a view to securing
monetary stability and fuller utilization of the country’s productive resources.’

SBP focuses on achieving monetary stability by controlling inflation close to its annual and
medium-term targets set by the government. At the same time, SBP also aims to ensure
financial stability, particularly the smooth functioning of the financial market and the
payments system. Consensus in literature as well as country experiences suggests that price
and financial stability facilitate the achievement of sustained economic growth in the long-
run.
Monetary Policy Decision-Making in Pakistan
 Monetary Policy Decision-Making Body

Monetary Policy Committee is responsible and fully empowered to decide the monetary policy
stance. Section 9E of the SBP Act 1956 lays out the powers and functions of the Monetary
Policy Committee that have been mainly identified as to:

(a) formulate, support and recommend the monetary policy, including, as appropriate,
decisions relating to intermediate monetary objectives, key interest rates and the supply of
reserves in Pakistan and may make regulations for their implementation;

(b) approve and issue the monetary policy statement and other monetary policy measures.

Members of Monetary Policy Committee