Mid Term Question
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In recent years, the State Bank of Pakistan (SBP) has been heavily criticized for its handling of the country’s monetary policy. The SBP seems to have failed in achieving its main targets which include managing inflation, promoting investment and saving growth, boosting financial sector efficiency, and lowering poverty and unequal access to financial resources. Interest rate has been considered an integral tool of monetary policy for controlling inflation. Since the past few years central bank of Pakistan tried to smooth the price fluctuation through raising interest rate. Currently Pakistan’s central bank raised its benchmark interest rate by 100 basis points to 22% but failed to achieve its target. Most of the researchers considered that open market operations are more effective tool as compared to the interest rate in eradicating inflation.
Being the students of the “Issues in the economy of Pakistan”, Discuss, whether the “Open market operations” as a monetary policy tool is more suitable in controlling inflation or not? Logically justify your answer with at least two arguments/examples.
Please note that the answer should be written in OWN words (maximum 200 words).
Monetary policy plays a crucial role in managing inflation and fostering economic stability. In the context of Pakistan, the State Bank of Pakistan (SBP) has faced criticism for its handling of monetary policy. This discussion aims to evaluate the effectiveness of open market operations as a tool for controlling inflation in Pakistan.
Open market operations involve the buying and selling of government securities in the open market. When the central bank sells these securities, it reduces the money supply in the economy. By reducing the available funds, open market operations can help curb inflationary pressures. For instance, if the SBP sells government securities, it absorbs excess liquidity, which can reduce inflationary pressures and promote price stability.
Open market operations have a direct impact on interest rates in the economy. When the central bank sells government securities, it reduces the supply of money in the market, leading to an increase in interest rates. Higher interest rates discourage borrowing and spending, thereby curbing inflation. This mechanism helps control inflation more effectively than relying solely on changes in the benchmark interest rate.
In recent years, Pakistan has faced significant inflationary pressures. Despite raising the benchmark interest rate, inflation remained stubbornly high. In such situations, open market operations can be more effective. By reducing the money supply through the sale of government securities, the SBP can directly target the excess liquidity causing inflation.
Many central banks worldwide have found open market operations to be an effective tool for controlling inflation. These include the Federal Reserve in the United States and the European Central Bank. Pakistan can learn from their experiences and implement similar strategies to achieve better results in managing inflation.
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