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The Reserve Equation and The Analytics of Pakistan's Monetary Policy

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  • Hassan, Rubina
  • Mirza, M. Shahzad

Abstract

This paper deals with the computation and analysis of some fundamental reserve aggregates and associated monetary statistics which impart important information regarding the design and conduct of monetary policy at the State Bank of Pakistan. Specifically, we compute the data series for borrowed, unborrowed, free and drainable reserves using balance sheet data published by the State Bank of Pakistan for the period 1985-2009. Results show that Pakistan’s monetary policy revolves around managing the exchange rate while using the t-bill rate as the key policy instrument. However, the value of the t-bill rate is both incorrectly and sub-optimally related to macroeconomic fundamentals rendering monetary policy time inconsistent. This hinges on the finding that since 2000-01, State Bank of Pakistan is targeting net free reserves of the banking system at 4% of total private deposits. Among other observations, we find that the scope of open market operations as a tool of monetary policy remains but limited and that this limited role of open market defenses derives from an indiscreet concern of the central bank to sterilize its own foreign exchange reserves. Furthermore, the growth rate of unborrowed plus drainable reserves bears a strong negative correlation with the annual average rate of inflation, which, on account of the former being consistently negative since 2005, implies that the government and the State Bank of Pakistan both have absolutely no concern for controlling inflation.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 32149.

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Date of creation: Nov 2010
Date of revision: Apr 2011
Publication status: Published in The Lahore Journal of Economics 1.16(2011): pp. 111-142
Handle: RePEc:pra:mprapa:32149

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Keywords: Measurement of Money Supply; Analysis of Monetary Policy; Central Banks and Their Policies; Taylor Rule; Operational Targets of Monetary Policy.;

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  1. Hassan, Rubina & Shahzad, Mirza Muhammad, 2011. "A macroeconometric framework for monetary policy evaluation: A case study of Pakistan," Economic Modelling, Elsevier, Elsevier, vol. 28(1-2), pages 118-137, January.
  2. Clarida, Richard & Galí, Jordi & Gertler, Mark, 1998. "Monetary Policy Rules and Macroeconomic Stability: Evidence and Some Theory," CEPR Discussion Papers, C.E.P.R. Discussion Papers 1908, C.E.P.R. Discussion Papers.
  3. Peter Clark & Sung Kwack, 1976. "Asset markets and interest rate determination in the multi-country model," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 94, Board of Governors of the Federal Reserve System (U.S.).
  4. David B. Gordon & Eric M. Leeper, 1992. "The dynamic impacts of monetary policy: an exercise in tentative identification," Working Paper, Federal Reserve Bank of Atlanta 92-13, Federal Reserve Bank of Atlanta.
  5. Michael Dooley & Peter Garber, 2005. "Is It 1958 or 1968? Three Notes on the Longevity of the Revived Bretton Woods System," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 36(1), pages 147-210.
  6. Favero, Carlo A & Rovelli, Riccardo, 2003. " Macroeconomic Stability and the Preferences of the Fed: A Formal Analysis, 1961-98," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 35(4), pages 545-56, August.
  7. Abbas Mirakhor & Iqbal Zaidi, 2006. "Foreign Currency Deposits and International Liquidity Shortages in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, Pakistan Institute of Development Economics, vol. 45(1), pages 49-85.
  8. Bindseil, Ulrich, 2004. "The operational target of monetary policy and the rise and fall of reserve position doctrine," Working Paper Series, European Central Bank 0372, European Central Bank.
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Cited by:
  1. Naz, Farah & Mohsin, Asma & Zaman, Khalid, 2012. "Exchange rate pass-through in to inflation: New insights in to the cointegration relationship from Pakistan," Economic Modelling, Elsevier, Elsevier, vol. 29(6), pages 2205-2221.

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