Chapter 18: Monetary Policy 3/17/14 9:05 AMFederal BSAssets

Securities(US Treasury Bonds) Foreign Exchange Reserves

Liabilities Reserves(Payable)

Banking System Assets

o Reserves(Receivable)o Securitieso (

Foreign Bondo Original Currencyo From a Foreign Countryo

Discount LoansWithdrawalsDRB

Assetso

Liabilitieso

Monetary Base: High-powered Money Currency + Bank Reserves

M1=Cash + Demand Deposits M1= M1 + MMDA + Time Deposits + CD ≤100,000 M3= M2 + CD>100,000

Expansion MultiplierA.

Assetso Reserves Securities +o Securities –

B. Assets

o Reserves 0o Securities –o Loans +

Liabilitieso Checkable Deposits

C. Assets

o Reserves 0o Securities –o Loans +

Liabilitieso Checkable deposits 0o

Quantity Theory and the Velocity of MoneyVelocity

The number of times a dollar is usedQuantity of Money * Velocity=Nominal GDPNominal GDP= Price Level*Real Output Nominal= Current Price

d/dxM + d/dxV= d/dxP + d/dx YMoney Growth+ Velocity Growth=Inflation + Real GrowthDouble M => Double PriceInflation is a monetary phenomenon

The Demand fo MoneyQuantity of Money

On their nominal income Cost of holding money The availability of substitues

Nominal Interest Rates People reduce their checking account balance Shift funds into and out of higher yield

3/17/14 9:05 AMMultiplicador monetarioModelo donde no existe demanda del publico por cash

Reservas Requeridaso R*deposito a la demanda = RR =o R* /\ Do

Total de Reservas = Requeridas + Excesivas = R = RR+RE

Chapter 18: Monetary Policy 3/17/14 9:05 AMUsing interest rates to stabilize the domestic economy

Inflation rate 2%…………………………………………………………..20140326FED controls the supply of money, completely.

Long Term Interest Rates: Average of Short Term interest ratesMarket Grop

Stabilize the funds rate Use both temporary and permanent open market operations

o Temporary are every dayo Permanent about once a week

Temporary Open Market Operations Use repurchase agreements Deciding the level if reserves is comlicated and uses information

from:o Treasury about their Balanceo Reserve

Discount Lendingo Not an important part of day-to-day monetary policy

Primarily to avert crises: Central Bank is the lender of last resort.

European Central Banks*Overnight Cash Rate = ECB equivalent to Federal Funds Rate

Main refinancing rate:o Rate on a weekly auction of 2 weeks maturity from central

Banks to the comercial Banks. Marginal Lending Facility(Discount Window)

o ECB makes loans at a target OCR*o +100 bps

Deposit Facilityo ECB pays interest at target OCR*-100 bps (

20140328 Operating Instruments

o Interest rates, Monetary Base Intermediate target

o Monetary Agrregates (M1,M2 Objectives

o Low inflation(2% goal**), Growth, stable interest ratesoo

Taylor Rules (tracks behaiviour)o Taget Fed Funds rate = 2.5 + Current inflation+.5(inflation

gap) + .5(Output gap)***o

*** All resources are working (Workforce,Capital,Ventures) unemployment is posible

When inflation(18-30) Fisher Effect****

Exchange Rate Policy and the Central Bank 3/17/14 9:05 AM

Capital Flows

Purchasing Power Parity One unit of domestics currency will buy the same basket anywhere

in the world

%/\ Exchange rate = Inflation DifferentialCentral Bank must choose between controling inflation or fixing the Exchange rate.

Interest Rate Parity

If the Exchange rate is fixed interest rate must be the same.If the interest rates differ, funds will move to equate them.

Higher inflation-Lesser value of Currency

20140407

The mechanics of Exchange RateIntervention increases reserves causing interest to fall.

Increases investors desir to move funds out of the countryAffects value of the dollar by changing domestic interest ratesFOREX intervention affects the value of a country’s currency by changing interest ratesOpen market desk sterilizes the intervention

Fixed Rates: Benefits Eliminates Exchange rate risk.international trading easiers Reduces risks of investing abroads Tie policymakers’s hands

CostEliminates stabilization effects of ExchangeRequires a high level of foreign Exchange reserves***If goverment need to incresase the money supply(goldstandard) doesn’t the money have the

Correlation by language and