Banking sector plays vital role in the capitalist economies all over the world e

Question

Banking sector plays vital role in the capitalist economies all over the world especially this role also gets significance in the developing countries like Pakistan. Policies of Central Bank, imposed on the commercial bank and financial sector, are considered as one of the key factors to boost the economy and control the inflation.

“If all commercial banks in Pakistan increase the small loans limit to Rs. 200,000 for general public at very low interest rate along with relaxed terms and conditions. Such loans will be used only for personal use and luxury items. What will be the effect of this activity of commercial banks on the money supply, inflation, Balance of payment (BOP) and real growth?”

You are required to answer/comments in the following table, which show only which component increases or decreases or both situations are possible”

Explanation / Answer

Money Supply       : Increase. If banking sector provide loans at low interest rate and with relaxed terms and condition. Money supply would increase dramatically.

Inflation : Increase. If there is increase in money supply then inflation scale would also rise up.

Balance of payment (BOP) : Increase or decrease due to excess money supply into the economy.

Real Growth : Decrease due to use of excess money supplied for luxury and personal items being the unproductive nature.

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