Monetary Policy Transmission Mechanism in Pakistan: What We Know and What We Need to Know?

This study, drawing on domestic and international literature and new empirical results, finds that monetary policy affects inflation and output in Pakistan, but transmission is slow, incomplete, and uneven across channels due to entrenched structural frictions. The interest rate channel influences short-term market rates, yet pass-through to deposit and lending rates remains weak amid banking concentration, large sovereign portfolios, and distortions from concessional refinance schemes. The exchange rate channel reacts faster, with tighter policy supporting nominal appreciation and easing tradable inflation, but credibility gaps, discretionary interventions, and shallow FX markets reduce predictability. The credit channel tightens private credit, though fiscal dominance, high NPLs, and bank inefficiencies dilute responsiveness. Asset price transmission is largely absent given shallow capital markets and informality. Policy signals can shape inflation expectations, but repeated external shocks and administered energy price changes often dominate the outlook. Importantly, the updated results indicates that post-COVID shocks developments – subsidized credit, commodity price spikes, floods, and exchange rate instability – have exposed the structural weaknesses and raised the premium on reform and fiscal-monetary coordination.