Upload
ianhorner3
View
617
Download
0
Embed Size (px)
Citation preview
Introduction to Monetary Policy
Introduction to Monetary Policy
3.) How Banks make Money
1.) Goals and Types of Monetary Policy
2.) Tools of Monetary Policy
4.) Monetary Policy Limitations
Monetary Policy
AD = C + I + G + (X – M)
- is the use of targeting inflation,
interest rates, and the exchange
rates to shift the AD curve.
Reworded definition: 换句话说
- is the use of changing the supply of
money to sustain economic growth
and smooth 连出 the business cycle.
1.) Goals and Types of Monetary Policy
- An increase in the money supply to
increase AD
Expansionary
Monetary Policy
AD = C + I + G + (X – M)
Inflationary
Monetary Policy
orDefinition with arrows: 换句话说
***Ceteris Paribus
Money Supply Shifts AD right
1.) Goals and Types of Monetary Policy
AD = C + I + G + (X – M)
Contractionary
Monetary Policy
Deflationary
Monetary Policy
or
Money Supply
***Ceteris Paribus
Definition with arrows: 换句话说
Shifts AD left
- An decrease in the money supply to
increase AD
Expansionary Monetary Policy
1.) Goals and Types of Monetary Policy
Time
Long Run
Short Run
Econ
Growth
Use Contractionary
Monetary Policy
Use
Expansionary
Monetary Policy
Monetary Policy - is the use of changing the supply of
money to sustain economic growth
and smooth 连出 the business cycle.
Time
Long Run
Short Run
Business Cycle
Econ
Growth
Monetary Policy - is the use of changing the supply of
money to sustain economic growth
and smooth 连出 the business cycle.
- Basically,
monetary
policy aims to
stabilize
economic
growth,
avoiding a
boom and
bust economic
cycle.
Introduction to Monetary Policy
1.) Goals and Types of Monetary Policy
2.) Tools of Monetary Policy
3.) How Banks make Money
4.) Monetary Policy Limitations
1.) Reserve Requirements (rr)
2.) Interest Rates (ir)
3.) Open Market Operations (omo)
4.) Exchange Rate Controls (Forex controls)
5.) Quantitative Easing (QE)
2.) Tools of Monetary Policy
AD = C + I + G + (X – M)
How the Tools of Monetary Policy work
(PED > 1)
AD = C + I + G + (X – M)
Money Supply
Price
level
GDP
AD
SRAS
PE
LRAS
YN Y1
P1
AD1
***(PED > 1)
1.) Goals and Types of Monetary Policy
- More money mean
more possible
transactions and
investment in the
economy, however can
lead to inflation.
1.) Reserve
Requirements
(rr)
- the minimum fraction of customer deposits that each commercial bank must hold as reserves.
(rather than lend out).
Definition with arrows: 换句话说
***Ceteris Paribus
the (rr)
2.) Tools of Monetary Policy
Money Supply Shifts AD right
Liabilities Assets
$100
Let’s say the (rr) is 10% percent
(rr)
Let’s say people deposit $100 in the bank
The bank can make lots of loans and increase the money supply a lot
10% Cannot be lent out
loans
+ $90
2.) Tools of Monetary Policy – Reserve Requirements
90% Can be lent out
Reserve Requirements - the minimum amount banks have to keep in the bank and can’t lend out.
(rr)
MS AD=
$100
Let’s say the (rr) is 40% percent
(rr)
60% Cannot be lent out
loans
2.) Tools of Monetary Policy – Reserve Requirements
40% Can be lent out
Reserve Requirements - the minimum amount banks have to keep in the bank and can’t lend out.
(rr)
MS AD=
The bank can make lots of loans and increase the money supply by a smaller amount
Liabilities Assets
$100
Let’s say people deposit $100 in the bank
$100 + $40
2.) Interest
Rates (ir)
- The main rate charged to commercial banks from the central bank.
Definition with arrows: 换句话说
***Ceteris Paribus
the (ir) (discount/base rate)
Discount
Rate
What it is called in the US
Base
Rate
What it is called in the UK
2.) Tools of Monetary Policy
Money Supply Shifts AD right
- benchmark rate that some of the world's leading banks charge each other for short-term loans. (inter-bank)
the inter-bank rate
Federal
funds rate
What it is called in the US
LiborWhat it is called in the UK
2.) Tools of Monetary Policy
2.) Interest
Rates (ir)
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply Shifts AD right
2.) Tools of Monetary Policy – Interest rates
- The central bank rate can control all the other banks rates
Discount Rate or Base rate
- Rate the central bank charges to the commercial banks
- Rate banks charge to each other
Federal Funds Rate or Libor
(only to be used in uncommon times)
(more commonly used rate)
5%
6% 6%
8% 8% 8%
central bank
commercial banks
Bank customers
2.) Tools of Monetary Policy – Interest rates
- The central bank rate can control all the other banks rates
Discount Rate or Base rate
- Rate the central bank charges to the commercial banks
- Rate banks charge to each other
Federal Funds Rate or Libor
(only to be used in uncommon times)
(more commonly used rate)
central bank
commercial banks
Bank customers
Let’s say the central bank lowers it’s rate
2%
3% 3%
5% 5% 5%
Means lowers rates for I in AD so more investment spending MS = AD
3.) Open Market
Operations (OMO)
buying securities
- buying and selling government securities in an attempt to control interbank interest rates.
- ( libor –UK) - ( federal funds rate – US)
2.) Tools of Monetary Policy
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply Shifts AD right
2.) Tools of Monetary Policy - OMO- buying and selling government securities
in an attempt to control interbank interest rates.
MS AD=
Central bank goes out into the market and buys bonds and securities…
in exchange for liquid money.
central bank
Investors are commercial banks New money can now
be lend out or used for consumption.
4.) Exchange
Rate controls(FOREX controls)
increase Depreciation
- Managing the use of the countries money between countries.
2.) Tools of Monetary Policy
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply Shifts AD right
Marvel Land
DC Land
Marvel Land MoneyDC land Money
(Country B)(Country A)
FOREX graph example
D from B D from A
S from BS from A
A money = more valuable
B/AA/B
B money = less valuable
Appreciationin other country
Depreciationin this country
NX AD==Depreciation
5.) Quantitative
Easing (QE)
buying securities
- Buying and selling more types of securities.- used by central banks to stimulate the
economy when standard monetary policy has become ineffective.
2.) Tools of Monetary Policy
Definition with arrows: 换句话说
***Ceteris Paribus
Money Supply Shifts AD right
2.) Tools of Monetary Policy - QE- The same idea and OMO, but now the
bank just buys even more different types of securities.
MS AD=
Central bank goes out into the market and buys bonds and securities…
in exchange for liquid money.
central bank
Investors are commercial banks New money can now
be lend out or used for consumption.
Introduction to Monetary Policy
3.) How Banks Create Money
1.) Goals and Types of Monetary Policy
2.) Tools of Monetary Policy
4.) Monetary Policy Limitations
- banks keep a fraction of deposits as reservesand use the rest to make loans.
The central bank of a country establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits.
The reserve ratio, (rr)= fraction of deposits that banks hold as reserves
= total reserves as a percentage of total deposits
fractional reserve banking system,
部分准备
金银行制度
Excess reserves are bank reserves over and above its required reserves.
3.) How Banks Create Money
Liabilities Assets
$100
Reserves (rr)
deposit
10% Cannot be lent out
loans
+ $90
90% Can be lent out
3.) How Banks Create MoneyT-account: a simplified accounting statement
that shows a bank’s assets & liabilities.
Example: Banks’ liabilities include deposits,
assets include loans & reserves.
In this example, notice that
(rr) = $10/$100 = 10%.
$100
An Example with 3 different situations:
Suppose $100 of currency is in circulation.
To determine banks’ impact on money supply, we calculate the money supply in 3 different cases:
Case 1. No banking system
Case 2. 100% reserve banking system: banks hold 100% of deposits as reserves, make no loans
Case 3. Fractional reserve banking system
3.) How Banks Create Money
CASE 1: No banking system
Public holds the $100 as currency.
Money supply = $100.
3.) How Banks Create Money
No banks…no increase in the money supply…
Liabilities Assets
$100
Reserves (rr)
deposit
100% Cannot be lent out
$100
3.) How Banks Create Money
CASE 2: 100% reserve banking system
Public deposits the $100 at First National Bank (FNB).
Money supply =
currency + deposits =
$0 + $100 = $100
In a 100% reserve banking system, banks do not affect size of money supply.
Banks can’t make loans…
no increase in the money supply…
Liabilities Assets
$100
Reserves (rr)
deposit
$10 Cannot be lent out
$100 +90
3.) How Banks Create Money
CASE 3: Fractional reserve banking system
Suppose rr = 10%. Banks loans all but 10% of the deposit:
loans $90 Can be lent out
Liabilities Assets
$100
Reserves (rr)
deposits
$9 Cannot be lent out
$100 +90
3.) How Banks Create Money
Suppose rr = 10%. Banks loans all but 10% of the deposit:
Loans + Reserves
$81 Can be lent out
CASE 3: (Continued..) Fractional reserve banking system
Assets
$90
deposits
+81
LiabilitiesLoans + Reserves
$90
Liabilities Assets
$100
deposits
$8.10Cannot be lent out
$100 +90
3.) How Banks Create Money
Suppose rr = 10%. Banks loans all but 10% of the deposit:
Loans + Reserves
$72.90 Can be lent out
CASE 3: (Continued..) Fractional reserve banking system
Assets
$90
deposits
$90 +81
LiabilitiesLoans + Reserves
Assets
$81
deposits
+72.90
LiabilitiesLoans + Reserves
$81
The process continues, and money is created with each new loan...
Original deposit =
1-bank lending =
2-bank lending =
3-bank lending = ...
$ 100.00
$ 90.00
$ 81.00
$ 72.90...
Total money supply = $ 1000.00
3.) How Banks Create Money
In this example $100 or reserves generates $1000of money
Known as the Money Multiplier
CASE 3: Fractional reserve banking system
部分准备金银行制度
***A fractional reserve banking system
creates money, but not wealth.
The Credit multiplier = 1/rr.
In our example,
rr = 10%
money multiplier = 1/rr = 10
$100 of reserves creates $1000 of money
Credit multiplier
or
Money multiplier
- the amount of money the banking system generates with each dollar of reserves.
3.) How Banks Create Money
Introduction to Monetary Policy
3.) How Banks Create Money
1.) Goals and Types of Monetary Policy
2.) Tools of Monetary Policy
4.) Monetary Policy Limitations
At some point it stops being effective.
4.) Monetary Policy Limitations
A common expression about it is called,
“pushing on a string”
Liquidity Trap
4.) Monetary Policy Limitations
- injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective.
Money Supply Shifts AD rightLower
interest rates
*** Only leads to
more inflation
Liquidity TrapDiscount Rate or Base rate
Federal Funds Rate or Libor
central bank
commercial banks
Bank customers
Once the rate gets to 0% it’s not working to stimulate any more growth. 0%
0% 0%
0% 0% 0%
Reached the end of this tool and I in AD is not increasing with the lower rates.
Now what?
4.) Monetary Policy Limitations – Liquidity Trap
4.) Monetary Policy Limitations
Monetary policy can’t really help this problem.
Price
level
GDP
AD
SRAS
PE
LRAS
YN
SRAS1
Y1
P1
2.) Cost-Push
Negative supply shock
4.) Monetary Policy Limitations
The bad kind of inflation because it involves lower output.
Monetary policy can’t really help this problem, it only adds to inflation.
{
Price
level
GDPY
AS
Aggregate Supply is: Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase.
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
Where you are on this curve matters how
effective the policies can be.
Price
level
GDPY
Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
AD AD1
Can be very effective here...
AS
Price
level
GDPY
Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase.
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
AD
AD1
Can be effective here, but watch out for
inflation.
AS
Price
level
GDPY
Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase.
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
AD
AD1
ASNo longer effective now, you just have
inflation.
So to summarize…
AD = C + I + G + (X – M)
Money Supply
Price
level
GDP
AD
SRAS
PE
LRAS
YN Y1
P1
AD1
***(PED > 1)
1.) Goals and Types of Monetary Policy
- More money mean
more possible
transactions and
investment in the
economy, however can
lead to inflation.
1.) Reserve Requirements (rr)
2.) Interest Rates (ir)
3.) Open Market Operations (omo)
4.) Exchange Rate Controls (Forex controls)
5.) Quantitative Easing (QE)
2.) Tools of Monetary Policy
AD = C + I + G + (X – M)
How the Tools of Monetary Policy work
(PED > 1)
- banks keep a fraction of deposits as reservesand use the rest to make loans.
The central bank of a country establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits.
The reserve ratio, (rr)= fraction of deposits that banks hold as reserves
= total reserves as a percentage of total deposits
fractional reserve banking system,
部分准备
金银行制度
Excess reserves are bank reserves over and above its required reserves.
3.) How Banks Create Money
The Credit multiplier = 1/rr.
In our example,
rr = 10%
money multiplier = 1/rr = 10
$100 of reserves creates $1000 of money
Credit multiplier
or
Money multiplier
- the amount of money the banking system generates with each dollar of reserves.
3.) How Banks Create Money
4.) Monetary Policy Limitations
Price
level
GDPY
AS
Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase.
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
AD
AD1
Price
level
GDPY
AS
Aggregate Supply is:
Classical zone
Economy’s resources already are fully used so only prices increase.
Intermediate zone Increase in GDP can lead to an increase of inflation too.
Keynesian zone
So an increase in GDP wouldn’t mean an increase in inflation.
4.) Monetary Policy Limitations
AD
AD1
The endThank you