02-22-2009, 03:19 PM
Dear Participants
Both the recession and liquidity crunch, at present, have their roots in failure of mortgage companies in USA and fall of big banks. Unwise lending by mortgage companies triggered the two. Basically Federal Reserve (the Central Bank of USA) had a very loose monetary policy i.e. providing loans at very low rates, which increased money supply in the economy. All commercial banks on the globe get loans from their Central Banks at overnight rates, LIBOR, or 90 days T Bill rates, which are basically short-term loans, and lend this money at higher rate for long-term purposes. Spread between the two is their profit after deducting transaction costs. Later, Federal Reserve increased this short-term rate to adopt tight monetary policy, i.e. to contract money supply in the economy. One of the possible reasons was to make interest rates in the economy more reasonable so unproductive activities (like speculation, unnecessary spending by getting easy loans at lower rates, unnecessary investments in housing market etc.) would be curtailed. With the increase in short-term rates, the spread between long and short term rates became minimal, in results, commercial banks were less interested in lending at probably negative profits, i.e. after deducting transaction cost and bearing all risks it was no more attractive for commercial banks to lend. Another reason is, all commercial banks give short-term loans to each other from their excess liquidity. Since the fall of big banks, the commercial banks have become restrictive in lending to each other and holding money with them. Therefore, even for genuine investors, it has become more difficult to have bank loans for their projects at lower rates. This phenomena is called credit or liquidity crunch.
State Bank of Pakistan had to follow the path of almost all other Central Banks on the globe. But now the situation is very complex. At one side we have hyper-inflation due to loose money supply in the economy, unwise spending of successive Govtâs, influx of billions of $$$ after 9/11 and war on terror etc. If SBP increases interest rates (at which it lends to commercial banks and for export financing etc.), it would have negative impact on already low productivity in Pakistan. On the other side, to increase productivity, to combat with effects of US recession, and to improve liquidity position of commercial banks so they can increase lending to investors, if SBP lowers interest rates, thus increases money supply, then probable result would be more inflation. In my view, it is a quite complex situation for economy like Pakistan.
One of our major problems is we have short supply of quality experts at home including good economists and we donât let them work independently i.e. without influences/pressures. When we have any personal sickness we go to doctor and do whatever he says, but when it comes to economy, we donât pay attention to economists and do whatever is good for us personally no matter if it is bad for masses.
Regards
Both the recession and liquidity crunch, at present, have their roots in failure of mortgage companies in USA and fall of big banks. Unwise lending by mortgage companies triggered the two. Basically Federal Reserve (the Central Bank of USA) had a very loose monetary policy i.e. providing loans at very low rates, which increased money supply in the economy. All commercial banks on the globe get loans from their Central Banks at overnight rates, LIBOR, or 90 days T Bill rates, which are basically short-term loans, and lend this money at higher rate for long-term purposes. Spread between the two is their profit after deducting transaction costs. Later, Federal Reserve increased this short-term rate to adopt tight monetary policy, i.e. to contract money supply in the economy. One of the possible reasons was to make interest rates in the economy more reasonable so unproductive activities (like speculation, unnecessary spending by getting easy loans at lower rates, unnecessary investments in housing market etc.) would be curtailed. With the increase in short-term rates, the spread between long and short term rates became minimal, in results, commercial banks were less interested in lending at probably negative profits, i.e. after deducting transaction cost and bearing all risks it was no more attractive for commercial banks to lend. Another reason is, all commercial banks give short-term loans to each other from their excess liquidity. Since the fall of big banks, the commercial banks have become restrictive in lending to each other and holding money with them. Therefore, even for genuine investors, it has become more difficult to have bank loans for their projects at lower rates. This phenomena is called credit or liquidity crunch.
State Bank of Pakistan had to follow the path of almost all other Central Banks on the globe. But now the situation is very complex. At one side we have hyper-inflation due to loose money supply in the economy, unwise spending of successive Govtâs, influx of billions of $$$ after 9/11 and war on terror etc. If SBP increases interest rates (at which it lends to commercial banks and for export financing etc.), it would have negative impact on already low productivity in Pakistan. On the other side, to increase productivity, to combat with effects of US recession, and to improve liquidity position of commercial banks so they can increase lending to investors, if SBP lowers interest rates, thus increases money supply, then probable result would be more inflation. In my view, it is a quite complex situation for economy like Pakistan.
One of our major problems is we have short supply of quality experts at home including good economists and we donât let them work independently i.e. without influences/pressures. When we have any personal sickness we go to doctor and do whatever he says, but when it comes to economy, we donât pay attention to economists and do whatever is good for us personally no matter if it is bad for masses.
Regards
