Efficiency of Monetary Policy in Price Stability The maintenance of price stability is one of the principal objectives of macroeconomic management.

Inflation is said to occur when the general level of prices rise rapidly and persistently over a period of time. This kind of double digit inflation is undesirable to the public and policy makers. In an inflationary economy, it is difficult for money to act as a medium of exchange and store of value without adverse effects on output, employment and income distribution. In ensuring monetary stability, the Central Bank implements policies through the deposit money banks that guarantee the orderly development of the economy through appropriate changes in the level of money supply. The reserves of the banks are influenced by the Central Bank through its various instruments of money policy. These instruments include the cash reserve requirement, liquidity ratio, open market operations, primary operations and among others to influence the movement of reserves (Folawewo et al. 2006). Inflation causes uncertainty about future prices. This affects decision on expenditure, savings and investment and causes misallocation of resources. It also allows substantial redistribution of income and wealth from savers to borrowers. From the point of view of policy makers inflation hampers growth and development of an economy as it discourages savings and investment. These factors explain why policy makers put in a lot of efforts to reduce inflation and several authors focus attention on the issue (Folawewo et al. 2006). There is fairly widespread consensus among macroeconomists that the primary long-term objective of monetary policy ought to be a stable currency. Studies evaluating the costs of inflation have long established the desirability of avoiding not only high but even moderate inflation. However, there is still a serious debate on whether the optimal average rate of inflation is low and positive, zero, or even moderately negative. An important issue in this debate concerns the reduced ability to conduct effective countercyclical monetary policy when inflation is low. As pointed out by Summers (1991), if the economy is faced with a recession when inflation is zero, the monetary authority is constrained in its ability to engineer a negative short-run real interest rate to damp the output loss. This constraint reflects the fact that the nominal short-term interest rate cannot be lowered below zero|the zero interest rate bound. This constraint would be of no relevance in the steady state of a non-stochastic economy. In equilibrium with zero inflation, the short-term nominal interest rate would always equal the equilibrium real rate. Stabilization of the economy in a stochastic environment, however, presupposes monetary control which leads to fluctuations in the short-run nominal interest rate. Under these circumstances, the non-negativity constraint on nominal interest rates may occasionally be binding and so may influence the performance of the economy. This bound is more likely to be reached, the lower the average rate of inflation and the greater the variability of the nominal interest rate. In this context, \inflation greases the wheels of monetary policy," as Fischer (1996) points out. (p. 19.) The effectiveness of monetary policy has been a long-standing question in the monetary economics and central banking literature. Perspectives on the question have been influenced in part by developments in monetary theory and in part by interpretations of monetary history. What do analysts mean by monetary policy and the effectiveness thereof? Each term is something of a moving target. These days economic recession is being faced by all countries whether they are developed, under developed or developing one. The major concern faced by all countries is of continued rise in prices i.e. inflation. It is caused due to various reasons such as: Inflation rates are increasing significantly in comparison to the earlier periods. Theres a high rate of unemployment coexisting with inflation, which apparently is a new experience and has made inflation almost uncontrollable in this global recession era. Developing countries may face difficulties in establishing an effective and operative monetary policy. The primary difficulty faced is that a few developing countries have deep markets in government debt. The matter is further complicated by the difficulties in forecasting fiscal pressure and money demand to levy the inflation tax

by rapid expansion of the monetary base. The central banks have poor records in managing monetary policy in many developing countries. This often happens when the monetary authority is not independent of government in developing countries, thus good monetary policies are left behind in the political desires of the government or are used to quest for other non-monetary goals. For this and other reasons, a currency board or dollarization may be instituted by developing countries that want to develop a credible monetary policy. Such forms of monetary institutions restrict the government from interference and it is desired that such policies will import the monetary policy of the anchor nation. Controlling inflation has been a top priority for policy makers all over the world since the 1970s. It is a consensus amongst economists and policy makers that price stability is the prime objective of monetary policy despite of a long and unsettled theoretical debate. Thus, it is the responsibility of the central bank to maintain price stability and it is accountable for not achieving price stability. The recent inflationary rise in developing countries has once again triggered a debate on the causes and factors responsible for inflation, which is similar to the debates that took place duing the nineties (90s). Policy makers are even divided on the issues of inflation. Some of the policy makers have contended that the current inflation has been caused by cost push factors such as oil price increases and wheat procurement price. Whereas, on the other side it is argued that accommodative monetary policy is responsible for the current heave in inflation. Further, it has been pointed out that monetary overhand is a cause of inflation. It is not surprising that the policy making authorities are indicating those factors that are beyond their control as the cause of inflation and commentators are targeting SBP for its inability to control money supply growth and policy failure. The main objective of this study is to assess the effectiveness of monetary policy in controlling inflation in Pakistan. The core objective of the thesis is to investigate whether the currently adopted monetary policy has been effective in controlling the inflation rate. INFLATION Inflation is termed as a rise in prices that causes a nations purchasing power to fall. As long as the annual percentage of inflation remains low, it is a normal economic development; once the percentage rises over a predetermined level, then its considered as an inflation crisis. WHAT CAUSES INFLATION? There can be various causes for inflation, depending on a number of factors or variables. For e.g. inflation takes place when government prints money in excess to deal with crisis; as a result of which prices end up rising at high rates to keep up with the currency surplus. This phenomenon is termed as demand-pull, in which prices are forced upwards due to high demand. The rise in production costs is another cause of inflation, which leads to an increase in the final price of products. For e.g. if the price of raw materials increase, this may lead to increasing the production cost; thus in turn leading the company to increase the product prices to maintain steady profits. Rise in labor costs can also lead to inflation. As workers demand increase in wages, the companies choose to pass on those costs to their consumers/customers. Inflation is also caused by national debts and international lending. As nations borrow money, they have to pay interest, which in turn causes prices to rise as a way of keeping with their debts. A major drop in the exchange rate can also result in inflation as the government may have to deal with the differences in the level of import/export. Finally, federal taxes on consumers such cigarettes or fuel can also cause inflation. As the taxes rise, the same burden is passed over to consumers by the supplier; the catch however is that once the prices increase, they rarely go back even if the tax rates are reduced at later stages. Wars are also often the cause for inflation since the government must both recoup the spent money and repay the borrowing from the central bank. War often

affects everything from labor costs to product demand to international trading, so in the end producing a rise in prices. MONETARY POLICY: Monetary policy is termed as the regulation of interest rate and the availability of money to maintain steady growth and prevent hard market crashes. An institution in charge of the monetary policy usually does it in two ways. One of the ways is by buying back securities from banks. This increases the reserves of the central bank, thus stimulating them to lend money to other institutions. The second way is to set interest rates at a certain level, which can also affect the economy. Monetary policy initially takes in account the performance of the economy. In difficult times, when the economy is sluggish, a lowering in interest rates may be needed to perk up borrowing. As borrowing increases, the economic activity associated with the borrowing may also increase, which in turn may create jobs and provide money to others. In case if the economy is going well, the Federal Reserve or other governing bodies may become concerned that there is ample growth, which could lead the economy up for a hard crash. In order to avoid any such incidents, the interest rates are increased to gently cool off the economy. However, any institution or governing body that monitors and controls the monetary policy needs to be aware that interest rates are correlated with inflation to a great degree. As the interest rates are lowered, money becomes cheaper for borrowing and is passed around more. This devaluates the currency rate by leading to an oversupply thus causing inflation to rise. If interest rates are increased, then inflation may decrease since there may be less money flowing through the system; thus making it more valuable. TOOLS OF MONETARY POLICY Monetary base: Monetary policy can be executed by varying the size of the monetary base. By doing so, it directly changes the amount of money circulation within the economy. In order to transform the monetary base, the central bank can use open market operations. In exchange of hard money, the central bank may sell/buy bonds. Upon collection/disbursement of the currency payment, the amount of currency is altered in the economy as a result altering the monetary base. Reserve Requirements: Implementation of the monetary policy can be ensured by varying the proportion of total assets held by banks as reserve with the central bank. The banks only retain a small portion of their assets in liquid form for attending immediate cash withdrawal needs; the rest is invested in illiquid assets such as loans and mortgages. By changing the proportion for the total assets to be held for immediate cash, the Federal Reserve changes the availability percentage of the funds that can be used for the purpose of granting loans. This acts as a change in the money supply. The central banks/regulatory authorities do not often alter the reserve requirements since it gives birth to the lending multiplier and creates very impulsive changes in the money supply. Discount Window lending: The opportunity provided to commercial banks and other depository institutions to borrow funds from the Central bank at a discount rate is termed as discount window lending. This rate is usually set below the short term (T-bill) market rate. It enables the banks to vary the credit conditions thereby affecting the monetary policy (i.e. the loan able amount). It is pertinent to note that the central banks cannot completely ensure control over Discount window, and its the only instrument this is not fully controlled by the regulatory authorities. Interest rates: The money supply contraction can be achieved by increasing the nominal interest rates indirectly. In different countries, varying levels of control over economy wide interest rates is observed by monetary authorities. In case of various nations, the monetary authority is able to authorize specific interest rates on saving accounts, loans and other financial assets. Rise in interest rates by the monetary authority can result in contracting the

money supply as elevated interest rates discourage borrowing and encourage saving. The size of the money supply is reduced by both of these effects. Currency board: A monetary arrangement that connects the monetary base one country to the other, the anchor nation is termed as a currency board. There are three principal rationales behind a currency board: To maintain a fixed rate of exchange with the secure nation To import monetary trustworthiness of the secure nation. Establishing reliability with the exchange rate. Unconventional monetary policy at Zero bound: Unconventional monetary policy is termed as other form of monetary policy used when interest rates are close or at 0% and occurrence of deflation is a matter of concern. These include signaling, quantitative easing and credit easing. The central bank acquires private sector assets, in order to improve liquidity and enhance access to credit in case of credit easing. In order to reduce market expectations for future interest rate, signaling can be used. For e.g. an indication was provided by the US Federal Reserve that the rates would be lowered for an extended period during the credit crisis of 2008. MONETARY POLICY TRANSMISSION MECHANISM A process through which the level of economic activity and inflation is affected by monetary policy decisions in the economy is termed as monetary transmission mechanism. Policy variables are affected with considerable lag and high degree of variability and uncertainty due to monetary policy actions, thus it is important to ascertain the impact and extent of monetary policy actions on the real variables. It is critical to ascertain which channels are more effective for transmitting changes in monetary policy actions in order to achieve policy goals. Financial sector developments regarding introduction of new financial products, technological changes, future policy expectations, institutional strengthening can ultimately change effects of the monetary policy measures. Theres a need to update, test and reinterpret transmission channels on a regular basis. Five basic channels of monetary policy are perceived to transmit the impact into the real economic activity. The first channel relies on the linkage between the short term nominal interest rate changes (i.e. by changes in policy rate) and the long term real interest that may affect the aggregate demand components such as investment and consumption within an economy. The changes in the long term real interest rates have an impact on business investment, aggregate consumption and other components of aggregate demand(AD). Secondly, changes in monetary policy that not only affects the net worth of firms to borrow (i.e. by affecting the ability to borrow) but also the lending ability of banks. The degree of allowance of the central bank to extend to which banks can extend their loans and dependence of the borrowers on the bank loans is the core strength of this channel. The aforementioned are clearly influenced by the regulations and the structure of the financial system. The third channel focuses on asset prices (i.e. other than rate of interest) such as real estate prices and market value of securities (equity and bonds).The price of bonds and stocks can be affected by policy induced changes in nominal interest rates, that may change the market value of firms relative to the replacement cost of capital thus affecting overall investment. Moreover, household consumption can be affected due to change in wealth as a result of change in price of securities. The exchange rate that in turn affects the net exports, foreign financial flows and thus aggregate demand are affected by policy induced changes in the domestic interest rate. The exchange rate channel strength is based on responsiveness of the exchange rate to monetary shocks, sensitivity of private inflows, net worth of firms, the degree of openness of economy and net worth of firms and their capacity of borrowing if they have taken any exposure in foreign currency. Moreover, changes in exchange rates lead to domestic price changes in consumption of imported goods and imported production inputs directly affecting inflation.

The fifth channel is based on the economic agents expectation of the prospects of economy in the future and stance of the monetary policy. As per the expectation channel, economic variables are mostly determined in a foreseeing manner and are impacted by the expected monetary (i.e. monetary policy) actions. Therefore, a credible, transparent and consistent monetary policy can potentially affect the economy path by affecting expectations. DEFINITIONS OF TERMS: Consumer Price Index: (CPI) measures changes through time in the price level of consumer goods and services purchased by households. Net Domestic Assets: (NDA) cater to dues of business entities and private individuals, the net borrowing of the public sector and the net balance of other items. In terms of accounting, it is defined as the difference between the volume of net foreign assets and the total money supply. Net Foreign Assets: (NFA) is termed as total asset value that a country owns overseas, minus the foreigner asset owned domestically. The NFA position of a country indicates the indebtedness of that country. Open Market Operation: is the means of implementing monetary policy by which a central bank controls the short term interest rate and the supply of base money in an economy, and thus indirectly the total money supply. Cost Push Inflation: is a type of inflation caused by substantial increases in the cost of important goods or services where no suitable alternative is available. LITERATURE REVIEW FOREIGN LITERATURE REVIEW Tightening Economic Policy: Withdrawing the drugs The world has been infuse with the biggest Keynesian blend yet seen. The governments have pushed cash into their economies to fight financial abduction and economic depression. The central banks have lowered interest rates; the rich worlds largest ones have supplemented ultra cheap money with a special drug named Quantitative easing (QE). This infusion has had a drastic impact on the world economy as it has prevented one of the biggest financial busts since the 1930s from triggering an economic disaster since the Second World War. Although most of the world economy is out of danger but the economy these days is hardly in good state. Emerging economies are showing rapid growth but in many rich ones such as Europe, the recovery is brittle. Economic growth is still dependent on government stimulant although their side-effects are also becoming evident. All this leaves the policy makers under question as to how and when to withdraw the stimulants. In other words, an Exit strategy needs to be followed which should address the following key areas: The Timing: To begin with the timing the policy makers have to avoid doing too much too soon as the same could kill the recovery, and similarly doing something too late may lead to budgetary crises and inflation. In case of emerging markets the decision is simple and clear since the recovery is robust, thus tightening of policies can be easily begun. The task is hard in big, rich economies where growth is brittle. The central banks in these economies have started by mainly unwinding the emergency liquidity facilities which were provided to avoid financial crises. Fiscal policy is distinct in this case since some countries like US are loosening further. Japan has also added to its deficit spending plans. Elsewhere, tighter budgets are at hand even in weak economies like Greece, Portugal and Spain, who hace risen taxes, and accelerated budget cuts. In regard to timing, there are mainly two school of thoughts. The first dominant one which includes the G7 finance ministers and IMF thinks that premature and incoherent exit from stimulus is a serious danger, and they dont want fiscal or monetary policy tightening in big or rich economies till 2011.It is believed that if they

tighten too early and world relapses then the mess would be far bigger and the policy makers might be out of tools for controlling the situation then. The latter, smaller but growing school thinks that Keynesian deficit spending has reached its limits and efforts for reducing deficits would enhance confidence and further counter the drag on demand from lower government spending. The logic comes from a theory called Ricardian equivalence which stated that government cannot boost the demand since the consumers cut down their expenses in view of expected higher taxes in future. Although both the school of thoughts dont provide the information to policy makers about when to start the process of tightening of policies, but they do suggest where the need for tightening is needed most urgently. The Tactic The second critical question is to determine the right mix of fiscal and monetary tightening .Since Second World war, most fiscal adjustments have led to lowering of interest rates and today central bankers have little room to offset budgetary issues by providing funds at cheaper rates. In theory they could expand QE, but the practice is not encouraged in practice. Stricter fiscal policies may lead to less monetary tightening. At first sight, the idea of having low interest rates for several years seems to be a good idea since the alternative of higher interest rates and big budget deficits would lead to debts at higher interest rates.Further, loose money and strict budgets may also result in weaker exchange rates, thus leading to rebalancing of global economy by weakening of rich country currencies relative to emerging countries. Since most of the rich economies have spare capacity, tighter budgets may restrict demand, thus keeping inflation unlikely to increase. This strategy has drawbacks. Even if consumer prices become stable, stretched periods of low interest rates in rich economies may fuel asset bubbles and other financial disorders. The Technique With QE, the central banks have two policy tools i.e. short term policy rates and the size of their balance sheets. Some worry that expanding the balance sheet may lead to inflationary risks whereas the counterpart is to keep excess reserve holding with central banks. In practice, both the tools are untested and thus the term Exit strategy may be a misnomer. In short, weaning the world off fiscal and monetary stimulants may take several years and like a former addict the economies would never be the same again.

SCENERIO OF BANGLADESH In FY10 and FY11 BB eased monetary policy significantly in order to cushion the impact of the global crisis on the Bangladesh economy. Due to this and other pro-active measures, the Bangladesh economy emerged largely unscathed fromthis global crisis, averaging over 6% growth between FY09 and FY11. In FY12 the economy faced a different set of challenges related to persisting inflationary and balance of payments pressures. In order to address these challenges BBs monetary stance took a more restrained stance while accommodating a near 20% private sector credit growth. The monetary growth targets set in January 2012 were met by the end of FY12 and key outcomes falling inflation and easing of external sector pressures were achieved. The July 2012 MPS had as its core objectives (i) limiting domestic credit growth to levels consistent with the FY13 single digit CPI inflation target (ii) ensuring that productive growth-conducive activities are not hampered by access to credit and (iii) preserving external sector stability including building reserves to more comfortable levels. Data for the first half of FY13 suggest that the achievement of these objectives is largely on track. Average inflation has been declining steadily over the past nine months, from a peak of 10.96% in February to 8.74%in December and within reach of the FY13 CPI inflation target of 7.5%. This decline has been due both to lower food and non-food price inflation with point to point non-food inflation declining from a peak of 13.96%in

March to 8.43% in December 2012. A measure of core inflation defined as nonfood, non-fuel, inflation also reflects these downward trends. In 2013, global growth is expected to be 3.6% with the average for developing countries projected at 5.6% and high income countries at 1.5% - a marginal improvement over 2012 and with significant downside risks in key trading partners. The overall credit envelope set by BB in July 2012, as shown by the most recent private sector credit growth data, was more than sufficient to meet the Governments growth target of 7.2%. However primarily due to the sluggish global economy various forecasts highlight significant dampening influences on this growth target. BBs forecast suggests that FY13 real GDP growth is unlikely to be less than the previous ten years average and may exceed it if global conditions improve. On the external front, gross foreign reserves were US$ 12.8 billion in end December 2012 and equivalent to about 4.0 months of import cover. The Taka: USD exchange rate has remained largely stable with the Taka appreciating by 2.6% between July 1st-December 31st. Pro-active steps to secure alternative sources of external financing for oil imports, lower import demand especially for food-grains, continuing export growth combined with strong remittance growth all contributed to this strengthened external position. There were three key developments related to monetary policy in H1FY13. First the sharp increase in foreign remittances (22% in H1FY2013) and lower imports contributed to a sharp increase in Net Foreign Assets. While this contributed to the much-needed reserve build-up, it also led to some over-shooting of monetary targets with broad money growth at 18.6%in November against a target of 16.2%. The second key development relates to the sharp decline in inter-bank rates which fell from a peak of around 20 percent in January 2012 to around 12% a year later. Customer deposit and lending rates remain more sticky, although with the decline in inflation and short term borrowing rates, these are expected to decline in the coming months. The third development centers around the healthy growth in private sector credit which grew by 17.4% in November 2012, while public sector credit growth was only 5%. Termloans are also nowless concentrated among large borrowers, with a growing share going to SMEs. BB is intensifying its focus on improving the transmission of monetary policy by strengthening market mechanisms and a key area is strengthening secondary market trading in government securities. Measures taken to this end include enhancing the shorter-dated portion of bills/bonds issues, where there is greater investor appetite, and launching an electronic trading window on BBs website. Financial sector stability is also important for effective monetary policy. Recent measures include tightening loan classification and provisioning requirements towards convergence with global best practices, introducing online supervisory reporting requirements on financial transactions and strengthening onsite and offsite vigilance. Various measures to detect fraud have been implemented; BB has strengthened its supervision capacity as well as reiterated the role that bank boards and management play in this regard. BB will focus on improving the quality, timeliness and transparency of reporting from the financial sector. BB will also commence special diagnostic examinations at the four SOCBs in early 2013 and will begin publishing a set of quarterly performance indicators on these banks. BB will continue to focus on ensuring that credit is used for productive purposes consistent with financial inclusion goals. BBs policies have also contributed to stabilizing the capital market and BB will continue to collaborate with the BSEC. The FY13H2 monetary policy stance is designed to ensure that the credit envelope is sufficient for productive investments to support the attainment of the governments FY13 real GDP growth target while keeping it consistent with the targeted 7.5% average inflation rate for FY13. In view of the risks to output growth due to the uncertainties around the global economy, BB will reduce all repo rates by 50 basis points effective immediately. BB has also revised its monetary programwith a broad money growth target of 17.7% in June 2013 compared to the FY13H1 MPS target of 16.5%, and a new private sector growth envelope of 18.5% in June 2013 compared with the original program of 18%. BB has created

further space in its monetary program in case there is greater lending appetite for productive purposes in H2FY13 and sufficient to accommodate even an optimistic scenario for FY13 output growth. At the same time BB remains committed to bringing inflation down further, and also to avoiding asset price bubbles, and as such continues to encourage banks to use the space for private sector growth for productive, and not speculative, purposes. This balanced monetary policy will also aim to minimize excessive volatility of the exchange rate. These objectives involve trade-offs and the balance between BBs instruments and its targets will be reviewed regularly. CONCLUSION The important conclusion that emerged from the analysis is that the money supply growth has been one of the key factors causing rise in inflation in a country during the study period. It is evident form the study that SBP is not effectively managing monetary tools to cater to the ever increasing inflation rate in the current era. RECOMMANDATIONS Following areas still need to be focused and addressed for ensuring effective monetary management: Effective co-ordination of monetary and fiscal tools would be helpful. Timely availability of data and integrity of data is extremely important for performing effective analysis of policy making and developments. Data on wages, employment and quarterly GDP etc is not available in developing countries. More substantial delays have been noted in availability of data on key variables such as large scale manufacturing output, government revenue and expenditure etc. Despite of being highly inflationary, liquidity management is highly affected due to Government borrowings from the central banks.The borrowing from the central bank results in liquidity being injected into the system by increased government deposits with banks and currency circulation. The impact of tight monetary stance is weakened in both cases, since the creation of money increases money supply without prior notice. Therefore, the prime task for improving effectiveness of monetary policy is to restrict the practice of government borrowing from central bank. The same can be achieved by introducing appropriate provisions to cease or minimize the limits of government borrowing from the central banks. It is essential to ensure that the above steps are carried out on priority basis. However, the same needs to be harmonized with much deeper structural reforms in order to synchronize and improve the med-term planning for monetary policy and budget formation. Several researches have provided significant guidance in this area, but the short term pressures and lack of capacities have often suspended such reforms. 7. REFERENCES

Uneasy lies the central bank that has to bear the burden of more than one goals. Bangladesh Bank finds itself in that unenviable position at present. Its burden consists of the goals to promote growth, contain and reduce inflation, help the capital market to grow without hiccup and prevent volatility in the exchange market. The difficulty of this onerous task is compounded by the global environment that continues to be anything but conducive for the achievement of the stated goals. Considering this the recently announced monetary policy by the Bangladesh Bank for the second half of the current fiscal year is nothing short of a bold attempt. But whether the boldness will succeed in steering clear of the shoals is, however, a different matter. First, a summary of the new monetary policy for the second half (H2) of the current fiscal is in order. The monetary policy that was unveiled on January 31 has been designed to attain maximum economic growth keeping in line with the government's real gross domestic product (GDP) growth target of 7.2 per cent. In

consonant with this objective the monetary policy has sought to ensure sufficient credit flow to the productive sectors, particularly in the private sector. In this regard the policy intends to maintain credit flow to the private sector at 18.5 per cent of the total, raising it from 18 per cent in the first phase (H1) of the monetary policy. To fulfill the objective the policy has cut base level interest rate for the first time since 2009, citing risks to economic expansion from uncertain global outlook. In keeping with this policy the central bank has lowered the bench mark repurchase (repo) rate to 7.25 per cent from existing 7.78 per cent. In doing this the Bank has taken note of the uneven global recovery that clouds Bangladesh's pivotal export in the garment sector. It has been emphasised that Bangladesh Bank will encourage credit growth in the private sector in an effort to attain GDP growth of 7.2 per cent as fixed in this year's budget. It has been pointed out that real GDP growth during 20122013 is unlikely to be less than the average of the previous ten years and exceed it if global condition improves. Commensurate with the private sector credit (PSC) target of 18.5 per cent compared to previous 18 per cent the broad money target has been fixed at 17.7 per cent, raising it from the previous 16.5 per cent. The monetary policy is expected to bring down inflation to 7.3 per cent from December's (2012) 7.9 per cent. In January 2013 food inflation fell 0.12 percentage point month-on-month to 7.21 per cent while non-food inflation fell 0.64 percentage point to 7.79 per cent. 'Inflation is moving in the right direction, which is why we were able to opt for a growth supportive reduction in repo rates', a senior official of Bangladesh Bank said to the press. Stibilising the capital market through greater volume of PSC has been the third objective of the monetary policy. The stock market has responded favourably to this, it seems. The Bank is optimistic that the announced monetary policy stance is well calibrated to prevent asset bubble in the capital market and 'irrational exuberance' in the financial sector. Finally, the monetary policy has sought to contain volatility in the foreign exchange market. Bold and ambitious: The above summary of the monetary policy shows that it has four main goals all of which are interlinked. It is the linkages among the goals which make their simultaneous achievement difficult, if not impossible. Given the challenge the monetary policy for the second half of the current fiscal appears not only bold but also ambitious. The prospects for the desired outcomes can now be discussed at some length. The new monetary policy envisages attainment of GDP growth at 7.5 per cent, as fixed in the budget for the current fiscal. Earlier the Bangladesh Bank had made forecast saying that real GDP growth would be between 6.1 to 6.4 per cent by the end of fiscal 2012-2013. The change in its stance on the subject seems to have been based on two assumptions. Firstly, the expanded volume of credit made available to the private sector and the broad money supply is expected to make attainment of the GDP growth possible. Secondly, the Bank is optimistic that real GDP growth in fiscal 2012-2013 is unlikely to be less than the previous ten years average. In response to these assumptions it may be pointed out that whether expanded volume of PSC will contribute to GDP growth depends on their investment in productive sectors. Increase in the volume of PSC through reduction of repo rate and thereby expanding broad money supply are helpful in augmenting investment but there is no guarantee that investment in productive sectors will take place, or if it will be at the desired level. Private investment declined 19.1 per cent year-on-year in fiscal 2011-2012 according to research organisation Policy Research Institute. According to it all the economic and non-economic indicators are pointing to significant shortfalls in investment and growth for fiscal 2012-2013. Increasing GDP growth requires expanding

the share of investment in GDP. Private sector credit (PSC), though a necessary condition, is not sufficient. In 2000-2001 the PSC-GDP ratio was 21 per cent and the investment-GDP ratio was 23 per cent. Even though the PSC-GDP ratio has more than doubled since then, the investment-GDP ratio has been only 26 per cent. The investment-GDP ratio in Bangladesh has to rise to at least 30 per cent to achieve a GDP growth rate of 7.0 per cent. Referring to 0.5 per cent reduction of repo rate and 0.5 per cent increase in the projection of credit for the private sector, Unnayan Gobeshana, a research organisation, has observed that such moves may ease the credit availability but would not pull investment to the required level for the attainment of the targeted growth in GDP, given the characteristics of the country's financial market, the lagged effect of change in repo rate and the availability of five months in the current fiscal. As regards the optimistic assumption about GDP growth rate being not less than the ten years' average it may be pointed out that even if the average may justify the forecast of GDP growth at 7.2 per cent on year-on-year basis, taking 2012-2013 separately the average may not match the achievement of this particular fiscal. Real GDP growth of current fiscal may be more or less than the ten years' average. Regarding inflation, the claim of relative reduction in average inflation owing to past monetary policy is not backed by evidence. The reduction of inflation in January 2013 to 6.62 per cent compared to December's (2012) 7.69 per cent is based on the 2005-2006 data for calculating consumer price index. Using the old base year of 1995-1996 the inflation in January 2013 on point-to-point basis was 7.38 per cent. For the same reason inflation in January 2012 was 11.59 per cent. Reduction in inflation already achieved is, therefore, an illusion. As regards the future one senior Bangladesh Bank official has said to the press, 'inflation risks remain high due to high remittance inflows in the first half of the fiscal 2012-2013, global commodity price trends and recent fuel price increases. The asset price may not avoid a bubble during the remaining period of the current fiscal in the context of the monetary policy just announced. Contrary to the expectation of the Bangladesh Bank if the additional credit made available to the private sector finds its way to this market. The high remittance inflow is also expected to put an upward pressure on asset prices. Banks in the private sector may be tempted to invest directly in the stock market as more fund is made available to it through reduction of repo rate. As regards volatility in exchange market, greater inflow of remittance and surplus in the current account of balance of payment (US$ 2226) as projected in the monetary policy will make volatility in the exchange market inevitable. With increasing flow of remittance, taka will keep on appreciating, destabilising the exchange market. The same can be said about continuing surplus in the balance of payment. The new monetary policy is bold and optimistic, it has already been pointed out. Objective conditions, already prevailing and gradually unfolding, may undermine the policy. The Bangladesh Bank will, therefore, have to be engaged on a regular basis with damage control in order to minimise the risks to the implementation of the monetary policy. The central bank in its latest half-yearly (January-June, 2013) monetary policy statement (MPS) has moved away slightly from its earlier contractionary, which the central bank preferred to term as accommodative, stance that it had been pursuing since the first half of 2010. It has cut both repo and reverse-repo rates by 50 basis points each and revised upward, albeit marginally, the targets for broad money growth and private sector credit. This has apparently been done with the objective of spurring investment and growth without fuelling inflation. Monetary policy can either be contractionary or expansionary in nature. While formulating its monetary policy,

the central bank of a country chooses its course of action between the two, on the basis of objective conditions prevailing in the economy at a given point of time. However the factors that basically influence the monetary policy decisions include maintenance of stable macro-economic conditions, promotion of generation employment opportunities and containing inflation. The Bangladesh Bank (BB) preferred a cautious monetary policy for the last three years primarily because of an unabated inflationary pressure. Such a stance could, at least, help keep inflation in check, to some extent, though it did not succeed much in reversing the price trends. This is because prices in the Bangladesh situation are influenced not alone by the monetary aggregates. A lot of other factors are also relevant here. However, the cautious monetary policy, as the available indications suggest, has partly been responsible for slowing down private investment because of high lending rates. Here, too, there are other factors both economic and non-economic, that have put a damper on new investment activities. The Bangladesh Bank (BB) has now opted for a change of gears on the monetary front, though somewhat cautiously, to help spur investment through encouraging expansion of credit to the private sector and also to accelerate the pace of growth. But it is difficult at this stage to preview things about the possible effects of the changed stance of the MPS that was announced last Thursday by the BB, particularly its likely impact on the level of private investments. There are other impediments such as under-developed infrastructures and unfolding political cross-currents in an uncharted territory that pose some difficult challenges to the overall performance of the national economy. Despite the fact that power situation has, of late, shown some improvements though at a huge cost to the public exchequer, the problem relating to gas supply still persists and it is very unlikely that the situation would improve soon. Politics is increasingly turning out to be not congenial to new investment-activities, with the political parties choosing to vent their anger on the streets. Moreover, the cut in repo and reverse-repo rate may not prompt any major change in the flow of long-term lending to the private sector because a good number of banks, being in troubles of different sorts, may not be in a position to lower their lending rates much. On the external front of the economy, the situation for the coming months may not also remain savoury as they were. Against this backdrop, the new MPS runs the risk of igniting fresh inflationary pressure which has been taking a toll on the consumers belonging to low and middle income groups. The on-going uptrend in prices of rice is about to negate the improvement noticed in the case of food-inflation during the past several months. More importantly, the attainment of the objectives of the MPS would largely depend on the developments on the fiscal front. This heightens the need for ensuring convergence of fiscal and monetary policies. Furthermore, the BB will have to be extra-cautious about monitoring the impact of its monetary policy. So far the developments on the fiscal front are concerned, the government that demonstrated so far during the current financial year (FY) some reasonable restraint on its borrowing from the banking sector, will increasingly come under pressure to go for more spending. This is because of the coming general election when various pressure groups exert pressure on such spending, without caring much about the resource availability situation.