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OSB > Lecture 6 > Flashcards

Lecture 6 Flashcards

1
Q

Banks HOLDING settlement cash are PAID what?

A

the OCR (+ a little bit)

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2
Q

Banks BORROWING settlement cash PAY what?

A

the OCR (+ a little bit)

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3
Q

What do the banks do in terms of their settlement cash when the OCR decreases?

A

they hold less in their settlement cash

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4
Q

What do the banks do in terms of their credit (loanable funds) when the OCR decreases?

A

they increase their credit which increases the money suppy

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5
Q

When the OCR is decreased, banks hold less in their settlement cash accounts. What does this mean for the amount of reserves they hold? What does this mean for the reserve ratio?

A

they are going to hold more in their other reserves so their reserves increase so the reserve ratio decreases because they then lend it out

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6
Q

What happens to the reserve ratio, loans and the money supply when the OCR decreases?

A

the reserve ratio decreases (banks hold onto less) and so loans increase and so the money supply increases

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7
Q

Who said that the money supply was vertical?

A

Keynes

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8
Q

If the money supply was vertical, what would that mean that loosening the OCR would do?

A

it would increase the money supply

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9
Q

What the purpose of settlement cash accounts?

A

for banks to settle their obligations with each other at the end of the day

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10
Q

Where can banks get money from if they can’t pay other banks at the end of the day from their settlement cash accounts?

A
  • the RBNZ can lend them the rest of the money and them charge them interest of the OCR and a little bit
  • bank A can owe bank B but A is charged interest
  • they can look into the inter cash market to borrow from other banks
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11
Q

What do the banks do if the OCR increases in terms of charging interest for bank A?

A

If the OCR increases, bank B might also increase interest to charge bank A

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12
Q

What is a 90 day bill rate?

A

This is a 90 day bond. The return on a 90 day bill rate and it tracks the OCR closely

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13
Q

Increasing the money supply _______ the economy (__________ spending) and puts ________ pressure on prices

A

stimulates
encourages
upward

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14
Q

Decreasing the money supply _______ spending and puts a __________ pressure on prices

A

discourages

downward

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15
Q

How does the RBNZ target inflation?

A
  • it adjusts the money supply so that prices in the economy remain stable
  • they have an inflation target of 1-3%
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16
Q

What is an exception to the target of 1%-3%?

A

when the economic activity is too low, the central bank might ignore the target

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17
Q

Define settlement cash

A

this is the deposits that banks keep with the RBNZ to settle their end of the day transaction needs

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18
Q

RBNZ pays _______ on settlement cash

A

interest

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19
Q

If a bank doesn’t have enough settlement cash to settle its account, it can borrow overnight from RBNZ. RBNZ charges interest on these loans.True or false?

A

true

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20
Q

The OCR is related to the interest paid on ________ __________ and the interest for ________ _______

A

settlement cash

overnight loans

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21
Q

What is the interest on settlement cash called?

A

the OCR

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22
Q

What is the interest on overnight loans called?

A

OCR + 50 points above the OCR

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23
Q

If the OCR was 4.5% then the interest on overnight loans is 5% and the interest on settlement cash is 4.5%. What is the highest wholesale rate a bank can charge on loans to other banks, and why?
What is the lowest retail rate a bank will charge on loans to customers, and why?

A

the highest wholesale rate a bank can charge on loans to other banks is 5% because otherwise their customers will borrow from the RBNZ

the lowest retail rate a bank will charge on loans to customers is 4.5% otherwise the bank could have deposited the money with RBNZ and made more profits

24
Q

As the OCR rises, what two rates increase?

A

retail and wholesale rates

25
Q

In contrast to Keynes theory which says that money supply is vertical and independent of interest rates, the money supply could related to the interest rates. Explain this

When the ________ rates rise in the economy banks wish to run down _______ and supply more _______. As a result, _________ reserve ratio _________. When the ORR falls, the _______ of money in the economy _______ through the fractional reserve banking system. Therefore, there is a _________ relationship between interest rates and the supply of money in the economy

A

When the interest rates rise in the economy banks wish to run down reserves and supply more loans. As a result, optimal reserve ratio falls. When the ORR falls, the supply of money in the economy rises through the fractional reserve banking system. Therefore, there is a positive relationship between interest rates and the supply of money in the economy

26
Q

What can cause the money supply to increase? Explain why

A

When the OCR falls, banks want to keep less in the reserves at the RBNZ since settlement cash deposits a lower return. At the current interest rate, the optimal reserve ratio falls. As a result, the money supply increases

27
Q

What can cause the money supply to decrease? Explain why

A

When the OCR rises, banks want to keep more in reserves at the RBNZ since settlement cash deposits earn a higher return. At the current interest rate, the optimal reserve ratio rises. As a result the money supply falls

28
Q

What does the RBNZ choose?

A

a target real interest rate that it thinks will obtain the goal of low inflation

29
Q

What happens to customers demand for credit, demand for goods and services and aggregate demand when the RBNZ raises the interest rate?

A
  • customers decrease their demand for credit
  • this decreases the quantity of goods and services demanded at any given price level
  • this shifts the “aggregate demand” to the left and reduces inflation pressure
30
Q

What does Taylor’s rule say?

A

That central bank raises real interest rates whenever expected inflation is higher than the target rate, or when there is an output gap

31
Q

In taylor’s rule, what does r(t) stand for?

A

target real interest rate

32
Q

In taylor’s rule, what does
_
r stand for? What does this mean?

A

assumed real interest rate

this is the returns on capital, risk in the economy (we are told this number)

33
Q

In taylor’s rule, what does α stand for?

A

this is a coefficient and it is 0.5

34
Q

In taylor’s rule, what does π(et) stand for?

A

this is the expected inflation

35
Q

In taylor’s rule, what does
_
π stand for?

A

this is the target inflation rate

36
Q

In taylor’s rule, what does β stand for?

A

this is a coefficient, this is 0 in NZ

37
Q

In taylor’s rule, what does [(yt-yt)/yt] stand for? What do each of these components mean and why can we ignore this in our case?

A

this is the output gap
yt is the actual GDP
y* is the potential GDP

we can ignore this because in NZ, the RBNZ only has an inflation target, not an output target

38
Q

Because RBNZ only targets inflation the central bank has the coefficient β = 0. This means that Taylor’s rule can be simplified to what?

A

_ _

rt = r + α [π(et) - π]

39
Q

nominal interest rate (i) =

A

real interest rate (r) + inflation (π)

40
Q

If there is inflation, what will the central bank do to nominal interest rates?

A

they will raise nominal interest rates by the inflation rate and then by the extra Taylor rule amount

41
Q

Suppose the assumed real interest rate is 3%. The target inflation rate is 2%. The expected inflation rate is 6%. The coefficient α = 0.5. What is the target real interest rate and what is the target nominal rate?

A 
assumed real interest rate
 _
(r ) = 3%, target inflation rate 
 _
(π) = 2%, α = 0.5, expected inflation rate (π(et)) = 6%. Therefore using Taylor's rule 
      _                  _
rt = r + α [π(et) - π], the target real interest rate is 
rt = 3 + 0.5(6-2) = 5%

The target nominal rate (i) is given by the Fisher equation:
i = real interest rate (r) + inflation (π)
so i = 5% + 6% = 11%

42
Q

What is on the x and Y axis of the yield curve?

A

on the x axis there is inflation over yearly periods (1 yr from today, 2 years from today, 3 years from today etc)

on the Y axis, there is the central banks’s targeted real interest rate (r)

43
Q

Central banks automatically change what when inflation changes

A

interest rate

44
Q

Central banks are characterised by being ________ or _______. What do these mean?

A

dovish (favours loose monetary policy)

hawkish (favours tight monetary policy)

45
Q

What does loose monetary policy mean in terms of nominal interest rates?

A

this means that for any given inflation rate, nominal interest rates are low (but as inflation gets higher, rates are still raised)

46
Q

What does tight monetary policy mean in terms of nominal inflation rate?

A

this means that for any given inflation rate, nominal interest rates are high (but as inflation gets higher, rates are still raised)

47
Q

A hawk has _______ interest rates for any value of inflation

A

higher

48
Q

If the central bank governor is a dove, what does this mean for interest rates and equilibrium inflation?

A

It means that interest rates are relatively low and equilibrium inflation can be expected to be high

49
Q

Do doves raise interest rates when inflation rises?

A

yes but the whole graph of interest rates is low

50
Q

The Taylor rule, the central bank’s forecast of the OCR path and the yield curve together mean that monetary policy and the yield curve are both __________ looking

A

forward

51
Q

Suppose the equilibrium real interest rate is 3%, the target inflation rate is 2% and the coefficient α = 0.5.
The current annual inflation rate is 2% and next year’s inflation rate is forecast to be 4%.
What is the current target nominal interest rate?

A

the current target rate is rt = 3 + 0.5(2-2) = 3%

hence the current target nominal interest rate is i(t) = r + π
i(t) = 3 + 2 = 5%

52
Q

Suppose the equilibrium real interest rate is 3%, the target inflation rate is 2% and the coefficient α = 0.5.
The current annual inflation rate is 2% and next year’s inflation rate is forecast to be 4%.
What is the expected future OCR?

A

The future real rate is r(t) = 3 + 0.5(4-2) = 4%

hence the future nominal target rate is
i(t) = 4 + 4 = 8%

53
Q

Suppose the equilibrium real interest rate is 3%, the target inflation rate is 2% and the coefficient α = 0.5.
The current annual inflation rate is 2% and next year’s inflation rate is forecast to be 4%.
What is the 2 year private interest rate?

A

the two year nominal interest rate is

2i(t2) = t(t1) + i([t+1]1)

hence the 2 year rate is
i(t2) = (5 + 8)/2 = 6.5%

54
Q

Taylor’s rule describes what?

A

How we are expecting the central banks to respond when inflation is set to rise

55
Q

If inflation rises, how would a hawk and dove repond respond?

A

in a hard way and try to crush it

in a softer way and just try to keep it under control

56
Q

What is loosening and tightening and how does this differ to hawkish and dovish?

A

Every time there is an increase in inflation, the reserve bank looks to increase interest rates to keep it under control. If we had a change in governor for the same kind of inflation changes, you could see the reserve bank governor being more hawkish.
Loose is when you tend to want to expand things, you’ve got low inflation and you can ease up on the OCR but tightening is when inflation might increase so you life the OCR (movement of policies) whereas hawkish and dovish is talking about how hard or how far you move each time

OSB (26 decks)

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