Effectiveness of Monetary Policy on Money and Credit in Pakistan

This paper analyzes the effectiveness of monetary policy on money and credit in Pakistan by using the data rich environment. FAVAR model is used which consists of 115 macroeconomic variable for the period 1992:01 to 2010:12. Results depict that after a positive shock in interest rate (discount rate), M0 and M1 do not show any significant response, while M2 shows an instantaneous decline and shows revival after 34 months. Credit to public sector enterprises and credit to private sector both decline after a positive shock in monetary policy but credit to private sector declines more than credit to public sector enterprises and M2. An increase in interest rate discourages private sector which leads to slowdown in the economic activities and creates pressure on prices to increase. In Pakistan, the adverse victim of monetary policy is credit to private sector, therefore policy should be tailored to consider the demands of credit by private sector. The policies should be made which provide the credit to private sector at a subsidized rate and the environment of investment should be promoted by the authorities in the country.