Group 2: What Have Been the Recent Changes in Monetary Policy Around the World, and What are the Implications on Different Asset Classes (Public Equity, Fixed Income, Private Equity, etc.)? Flashcards
what is monetary policy
the process by which a country’s central bank, such as the Federal Reserve in
the US or the Bank of Canada, manages the supply of money to achieve specific economic goals
what are examples of specific economic goals that central banks have
- Controlling inflation
- Increasing employment
- Promoting economic growth
what are 3 main tools central banks have
- Open-market operations
- Changes in reserve requirements
- Changes in the overnight rate
what monetary tool does the bank of canada currently use
the overnight rate
what is the bank rate
The interest rate charged by the Bank of Canada on loans to commercial banks
how much does the bank of canada pay commercial banks when commercial banks hold money in the bank of canada
bank rate - 0.5%
what is the overnight rate
The rate of interest on very short-term loans between commercial banks
how much is the overnight rate usually
be about 1/4% below the bank rate
how can the bank of canada change the money supply
- by changing the bank rate, which will cause an equal change in the overnight rate
- A higher overnight rate discourages banks from borrowing reserves from the Bank of Canada, so it will reduce the quantity of reserves in the banking system, reducing the money supply (they do this when they want to lower the money supply)
- A lower overnight rate encourages banks to borrow from the Bank of Canada, increasing the quantity of reserves, and increasing the money supply (they do this when they want to increase the money supply)
why does the overnight rate matter
it sets the pattern for all canadian interest rates
what are open market operations
The purchase or sale of government of Canada bonds by the Bank of Canada
how would the bank of canada increase the money supply
- buy treasury bills
- bank of canada are like the creator of money
- they by government bonds, giving money to the market
- more money is circulating = more money supply
how would the bank of canada reduce the money supply
- sell the government bonds to the public
- the public buys the bonds from them
- the bank of canada holds the money and doesn’t give it out anymore
- reduces the amount of money in circulation
what is quantitative easing
The purchase by the central bank of non-government securities or government securities with long maturity terms
what is quantitative tightening
- The sale by the central bank of non-government securities or government securities with long maturity terms
- also not reinvesting in bonds that mature
what are reserve requirements
Regulations on the minimum amount of reserves that banks must hold against deposits
how can money supply decrease with reserve requirements
- increase reserve requirements
- makes banks hold more reserves
- holding more reserves = they can loan out less money
- loaning out less money is less money they can make money out of (interest)
- money supply decreases
how can money supply increase with reserve requirements
- decrease reserve requirements
- makes banks hold more less reserves
- holding less reserves = they can loan out more money
- loaning out more money is more money they can make money out of (interest)
- money supply increases
which countries don’t have reserve requirements
- canada
- uk
- new zealand
- australia
- sweden
why do some countries not have reserve requirements
- they just don’t
- instead they have capital requirements (must hold a certain amount of capital)
- capital requirements help reduce the losses on loans and investments
what is expansionary monetary policy
- policies made to increase the money supply and boosting economic activity
- done by keeping interest rates low to encourage borrowing
what is contractionary monetary policy
- policy to reduce money supply aka fight inflation
- done by putting higher interest rates to discourage borrowing and encourage saving
why did the US recently cut interest rates
- they put high interest rates since 2022 (5.5%), which have been to fight inflation and to stabilize prices that were increasing significantly (after the pandemic)
- but they didn’t want it to be so high that it would restrict borrowing so much and end up hurting the US economy
- especially since inflation has be decreasing since the interest rate increase
- so they cut it by 0.5% (expansionary policy)
- they are aiming to have it around 4.75%-5%
what does monetary policy have to do with unemployment
- when interest rates are low, companies can borrow more money
- when they have more money they can spend it to invest in more projects or hire more people (more money can be given out as wages)
- when interest rates are high, they borrow less money
- they have less money to spend on projects and therefore can’t afford to have many workers (unemployment) let alone hire them
what kind of monetary policies did countries have during covid
- expansionary policies
- done to increase the money supply, reduce unemployment and boost growth
what kind of expansionary policies were done
- lowering interest rates: central banks lowered the rates to near zero (canada’s was set to 0.25%
- buying back government securities (open market operations)
what kind of monetary policies are countries doing after covid
- contractionary monetary policies
- like increasing interest rates to incentivizes saving and making it harder to borrow
- they are trying to control inflation to about 2%, which is their goal
- they consider it the % that maintains price stability while providing enough protection against deflation
what contractionary monetary policy did the european central bank do
increased rates from 0% in June 2022 to 4% in september 2023 across 9 separate increases
are increase interest rates actually reducing inflation
- according to the international monetary fund (IMF) global inflation is falling
- it went from 6.8% in 2023 to 5.9% in 2024
- its projected to fall to 4.5% in 2025
what happened to stocks (public equity) during covid
- central banks had expansionary policies where they cut interest rates
- cutting interest rates reduces the cost of borrowing, allowing businesses to get capital at lower prices, which they can invest in growth and maybe increase profit
- because of this, investors increased their investment in stocks, expecting higher returns from the company
what happened to stocks (public equity) after covid
- central banks had contractionary policies where they increased interest rates to fight inflation
- it increased the cost of borrowing, making it more expensive for businesses to get capital so they didn’t borrow that much
- this made it hard for a company to finance operations and expansions, which slowed their growth and shrunk their profit margins
- because of the fall in performance, the stock prices began to fall
what about the monetary policy changes on private equity
- moves similar to the public equity market
- except the market is less liquid than the public equity market (less buyers and sellers, and investments are more longer-term ones)
- because of this, private equity has a slower impact on the policy changes
what are different asset classes
- public equity (stocks)
- private equity
- fixed income (bonds)
- real estate
what happened to bonds (fixed income) during covid
- expansionary policy has an inverse relationship for bonds
- when interest rates are lower, it means that newly issued bonds have lower yields (lower interest payments)
- so the demand for newly issued bonds decrease
- but it also means that existing bonds have higher yields than new ones, increasing the demand for existing bonds and therefore increasing the price of them
- or people just move to something with higher returns like stocks over bonds
what happened to bonds (fixed income) after covid
- when interest rates are higher, it means that newly issued bonds have higher yields (higher interest payments)
- so the demand for newly issued bonds increase
- it also means that existing bonds have lower yields than new ones, decreasing the demand for existing bonds, and decreasing their prices
- this happens for more long-term bonds, so investors prefer short-term bonds to reduce their risk
- so when interest rates are higher people like to invest in more bonds instead of stocks
what happened to real estate (houses) during covid
- low interest rates during the pandemic
- made it more affordable to mortgage
- cheaper mortgages = more houses bought
- more houses bought = less houses available = houses become more expensive
what happened to real estate (houses) after covid
- interest rates were increased to fight inflation
- caused mortgages to be more expensive and slow down the housing market
what happened to office spaces during covid
- people worked from home
- so offices were either temporarily or permanently empty (vacancy rates increased)
- some companies even shifted to remote or hybrid work models increasing the vacancy
- people became more cautious about purchasing office spaces since they were now unsure about the demand for them even though interest rates were low
what happened to office spaces after covid
- hybrid work models still were popular
- with some companies still not having full time in office work, there are still pretty high vacancy rates (18.5%)
what happened to retail spaces during covid
- many brick-and-mortar stores especially small businesses were forced to close temporarily or permanently
- ecommerce boomed, so the demand for physical retail spaces decreased
what happened to retail spaces after covid
- high-end retail and essential services (like groceries) recovered pretty quickly
- smaller businesses and traditional department stores struggled
- ecommerce remains dominant
- many retailers have both online and in store channels
what is deflation
- when the prices of goods decreases, meaning the purchasing power of money is higher
- this can be good initially as consumers are able to buy more with the same money they have
- however with lower prices, companies would be earning less
- with less profits, companies may end up laying off employees to save costs, which would reduce the disposable income of individuals, causing them to in turn, spend less
