02: Monetary Policy Flashcards
What is Monetary Policy
- action taken by central bank to manage country’s:
1. money supply (reserve requirements)
2. interest rates
3. open market operations (buying and selling government securities)
What is the main goal of monetary policy
- acheive economic stability by contorlling:
1. increase money supply
2. unemployment
3. boost economic growth
Key Measures in Monetary Policies during Covid
- lowering interest rates
- central banks (Federal Reserve, Bank of Canada, reduced rates to near zero - buying back government securities
- central banks purchase large amounts of corporate and government bonds to inject more liquid cash into the system - emergency lending programs
- lending and benefit programs support businesses
After 2020, explain what happened to interest rates (4%) and how banks measures towards Covid
- hiked interest rates to incentivize saving and reduce borrowing
–> reduce consumer spending
–> too much activity in the economy results in inflation - maintain inflation at target rate of 2%
Why is inflation should stay at 2% a safe rate for banks
- help keeps inflation above zero
- gives banks enough room to maneuver and adapt to changing economic conditions (ex. covid 19)
Ex. If inflation is too low, central banks may struggle to lower rates in times of economic downturns
What does inflation rate 1% and 3% represent
1%: represent low inflation
- raise concerns about deflation and weak economic demand (low consumer spending)
3%: healthy economic growth but is risky
- if growth continues then expect continuous increase in prices
–> lead to economic crisis (ex. housing crisis)
What is quantitative tightening and easing
tightening: central banks sell securities or don’t reinvest the bonds that mature
- there’s less demand so the prices decrease
easing: buy large amounts of securities
- push up prices because now there’s more demand
What can we expect in future months
- cute rates once more
- tightening programs
- to increase money supply in response of the low economic activity
–> counterrespond to their actions right now
Covid 19 response on Public Equity (at first)
when market crashed, Federal Reserve cut interest rates near to 0
1. cost of borrowing (reduced)
2. growth
3. profit margins (increased)
- helped round from crash and stabilized the market
After Covid 19, what happened to public equity
- after covid 19, Federal Reserve shifted its focus to fighting inflation
- 2022 interest rates pushed up to 5.5%
–> sharp increase with little notice (over short period) made borrowing capital expensive
affects: to a weaker market
1. growth slowed
2. stock prices fell
What are the different challenges for private equity
- similar challenges to public equities
- harder for small business to fund growth or new acquisitions since they rely on private funding
Bonds During Covid
Quantitative easing cut interest rates:
1. existing bond prices increased
2. existing bonds were preferred
3. less demand for bonds (new ones)
Bonds after Covid
Quantitative Tightening: raised interest rates
1. existing bond prices decreased
2. new short term bonds were preferred
3. more demand for bonds
Explain Equities and Bonds Inverse Relationship
- interest rates
- newly issued bonds pay higher yields (make these more attractive)
- increase cost of borrowing for companies issuing equity - investment
- bonds are safer during increasing interest rates
- low interest rate would make investors to seek higher returns
Takeaway:
1. higher the interest rate the more expensive it is to borrow money (equity)
2. stock market goes up (from lower interest rate) - stimulates the company
How Monetary Policy was implemented through Covid
- expansionary policy during Covid
- stimulate economy through low interest rates & increased liquidity - contradictory policy after Covid
- combat inflation by raising interest rates & reducing liquidity
