Economics (AKU-ECO)
Topic 3 of 7Aga Khan Board

Money & Banking

Functions of money, commercial banks, central bank and monetary policy

Money performs four functions:

  • Medium of exchange: accepted for buying/selling goods
  • Store of value: holds purchasing power over time
  • Unit of account: used to compare values (prices)
  • Standard of deferred payment: used for credit/loans

    • Characteristics of good money: generally accepted, portable, durable, divisible, uniform (all notes of same denomination identical), scarce (limited supply).


    Commercial banks: (e.g., HBL, MCB, UBL in Pakistan) — accept deposits, give loans, offer services. They **create credit** — they lend out more than they hold in deposits. This expands the money supply.


    State Bank of Pakistan (SBP): Pakistan's **central bank**. Functions:

  • Issues currency (banknotes and coins)
  • Acts as banker to the government
  • Regulates and supervises commercial banks
  • Implements monetary policy

    • Monetary policy: Central bank controls money supply and interest rates to achieve economic goals:

  • Raise interest rates → borrowing more expensive → less spending → reduces inflation
  • Lower interest rates → cheaper borrowing → more spending → stimulates economy

    • Inflation: General rise in prices. Caused by excess demand (demand-pull) or rising costs (cost-push). Measured by Consumer Price Index (CPI). Pakistan's inflation exceeded 38% in 2023 — among the highest in its history.

    Key Points to Remember

    • 1Money: medium of exchange, store of value, unit of account, deferred payment
    • 2Commercial banks: accept deposits, give loans, create credit
    • 3State Bank of Pakistan: issues currency, sets interest rates
    • 4Higher interest rates → less borrowing → reduces inflation

    Pakistan Example

    State Bank of Pakistan and the 2023 Inflation Crisis

    In 2023, Pakistan's CPI inflation exceeded 38% — the highest in 50 years. The State Bank of Pakistan raised its benchmark interest rate to 22% (one of the highest in the world) to reduce borrowing and cool inflation. Higher interest rates made loans for cars, homes, and businesses more expensive, reducing spending. This is textbook SBP monetary policy — and a direct AKU-EB Economics case study.

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