Chapter 5- Monetary Policy Flashcards
Money Market
The Money Market is basically concerned with the issue and trading of securities with short term maturities.
– Maturity from 1 day to 1 year !!
– T-bills, Commercial Papers
Who operates in the money market?
- Especially interbank in trade
- Also institutional investors, governments and big companies
Functions of the money market
- Clearing of deficits and surplus´
— lending >< borrowing (short term credit) - Temporary funding of governments
— through treasury bills etc - Starting point of monetary policy
— By setting the “Main Refinancing Operations”
The interbank market
Where banks exchange funds with each other to balance their book
–> when the deposits are lower than the amounts clients have borrowed - need to borrow from other banks
–> when deposits are higher the banks can lend to other banks
–> the central bank injects or withdraws cash to calibrate the money market
–> if a major bank is suspected or not able to repay its loans the system is paralysed –> to restart the flow, the State may undertake guarantee loans between banks
- all international banks are in the trading system, its not separate market in Europe, the US, Japan etc
- However it is more natural for us to borrow money from other European banks
→ the next step will be to go to the central banks, if you can´t get it from the interbank market. This is a more expensive alternative
→ The Central Bank is called the last resort
Euribor
Short for Euro Interbank Offered Rate
- Euribor rates are based on the average interest rates at which a large panel of European banks borrow funds from one another. There are different maturities, ranging from one week to one year.
–> important benchmark
Role EURIBOR
Used for loans with floating interest rates
Example: Type of loan is 10/5/5
- First 10yr: fixed interest rate of 4%
- After 5 years: EURIBOR 3m + 2,5%
- After another 5 years: EURIBOR 3m + 2,5%
–> so a high EURIBOR makes your loan more expensive (and vice versa)
ESTER
The Euro Short-Term Rate is the 1-day interbank interest rate for the Euro zone.
- In other words, it is the rate at which banks provide loans to each other with a maturity of 1 day.
*Therefore ESTER can be considered as the 1 day Euribor rate.
The central bank
- Ensures price stability
- Controls money supply and decides interest rates
- Supervises that banks are safe
- Works independently from governments
President of the Central Bank
Christine Lagarde
Primary objective of the ECB
Price stability
- inflation must be under but close to 2%
Central banks can focus on:
Quantitative monetary policy: Central banks regulate monetary base (B=C+R), so change money supply
and/or
Qualitative monetary policy: Central banks change the market interest rate
Expansionary Monetary Policy
When the central bank raises the money supply, interest rates fall
- the economy moves down the money demand schedule
- lower interest rates reduces the costs of investment, thus higher investment raises aggregate demand curve
- quantitative easing program
Tight monetary policy
Central banks contracts the money supply in response to fears of rising prices
- lower money supply increases interest rates (money is expensive)
- the result of a tighter monetary policy is lower investments and decrease in the nation’s GDP
Toolbox of the ECB to “control” the economy
More qualitative monetary policy
–> change interest rates
Standing (=fixed) facilities
At the end of the day, the banks check their balance:
Deficit? Use marginal lending facility
Surplus? Use deposit facility
–> Happens overnight at NCB
Unlimited access but normally not very popular because the interbanking rates are better
