Monetary Policy Flashcards
What do central banks routinely do? (3)
They extend liquidity to banks
They extend liquidity to banks
They impose compulsory reserves on commercial banks
What are some of the exceptional measures a central bank could resort to in circumstance of financial stress?
Lenders of last resort to commercial banks
They may resort to so-called ‘unconventional policies’
Main Refinancing Operations (MRO)
The ECB’s regular open market operations consist of one-week liquidity-providing operations in euro
Minimum reserve requirements
Reserve requirementrefers to a certain amount of money commercial banks must keep as reserves in their current accounts at their central bank.
The monetary transmission mechanism
the process through which a central bank’s monetary policy decisions affect the economy in general, and the ultimate target variables (price level, output, employment,…) in particular.
Fixed-Rate Full Allotment
As the interbank market dried up in autumn 2008, and banks could no longer rely on borrowing from each other, the ECB amended its approach and provided unlimited credit to banks at a fixed interest rate
What are the two possible stances of monetary policy?
Expansionary/loose/accommodative monetary policy: low policy rate
Restrictive/contractionary monetary policy: high policy rate
What are the key objectives of monetary policy?
Maintaining price stability
Promoting maximum (full) employment
Maintaining the stability of the financial system
Exchange-rate stability
Which other objective has emerged during the late 1980’s?
Inflation targeting
Which Keynesian-inspired conviction is represented by the Philips curve?
That price stability
as a goal of economic policy had to be offset against the effort to achieve full employment
and higher economic growth
What is stagflation?
A combination of inflation and high and
persistent unemployment
What is the dual mandate of the Fed?
Ensuring price stability and maximum employment
What is the FOMC?
The Federal Open-Market Committee is the most important decision-making body which consists of:
- seven members of the Board of Governors
- five chairman of Reserve Banks
What is the ESCB?
The European System of Central Banks, which constists of the ECB and the national central banks of the member states
What are “Open market operations”?
Open market operations are central bank’s purchases or sales of financial instruments (in the
secondary market) from or to a private bank or a group of banks
What is objective of “Open market Operations”?
Taking or giving liquidity
What are “Lending operations”?
Standing facilities aiming to provide or absorb liquidity with an overnight maturity
What are “Minimum reserve requirements”?
Reserve requirement refers to a certain amount of money commercial banks must keep as
reserves in their current accounts at their central bank.
What is objective of “Minimum reserve requirements”?
The aim of the minimum reserves is to stabilise the short-term (money market) interest
rates.
How is the objectove of “Minimum reserve requirements” achieved?
The aim of the minimum reserves is to stabilise the short-term (money market) interest
rates. A low (high) reserve requirement allows commercial banks to lend more (less) of their
deposits. It is expansionary (restrictive) because it creates (reduces) credit.
What are the requirements for an intermediate target?
Must be measurable
Subject to some degree of central bank control
Predictable effect on the ultimate policy objectives
Which are the various transmission channels?
- Interest rate channel
- Asset price channel
- Credit channel
- External channel
Which are the various transmission channels?
- Interest rate channel
- Asset price channel
- Credit channel
- External channel
How does monetary policy affect the economy through the “Interest rate channel”?
monetary policy affects a range of interest rates and this then
affects investment and consumption decisions of companies and households
How does monetary policy affect the economy through the “Asset price channel”?
monetary policy decisions affect asset prices (given the negative
relationship between asset prices and interest rates), which in turn affects demand
through wealth effects and relative price effects
How does monetary policy affect the economy through the “Credit channel”?
monetary policy affects the supply of bank credit through the change in
interest rates and asset prices
How does monetary policy affect the economy through the “External channel”?
monetary policy affects the exchange rate, which influences the price
of imports and exports.
What is a discretionary or activist policy regarding monetary policy?
A discretionary or activist policy implies that the stance of monetary policy is regularly adjusted to prevailing economic conditions
What are fixed rules regarding monetary policy?
The government can also use fixed rules which are expected to lead to the best results for monetary policy in the long run
What is the main advantage of monetary policy over fiscal policy?
A major advantage of monetary policy is that the delay due to decision procedures (internal
delay) is much shorter than in active fiscal policy,
What is the main advantage of monetary policy over fiscal policy?
A major advantage of monetary policy is that the delay due to decision procedures (internal delay) is much shorter than in active fiscal policy,
What is the main disadvantage of monetary policy over fiscal policy?
On the other hand, the external delay may be large and
variable.
Indeed, monetary policy acts indirectly on aggregate demand, in contrast to fiscal
policy, which can act more directly
What is the Mundell-Fleming Trilemma? Also known as the
impossible or inconsistent trinity
Countries cannot simultaneously
fix their exchange rate, open their capital account (i.e., free capital
mobility), and conduct an independent monetary policy. Only two of
the tree are possible.
What is “Fixed-Rate Full Allotment”?
• In the first phase of the financial crisis, that began in 2007, the primary aim of the ECB’s nonstandard measures was to provide liquidity to banks and to keep financial markets functioning.
As the interbank market dried up in autumn 2008, and banks could no longer rely on borrowing
from each other, the ECB amended its approach and provided unlimited credit to banks at a
fixed interest rate
What where some of the unconventional measures taken by the ECB to address markets’ malfunctioning and to reduce differences in financing conditions?
- The ECB
purchased debt securities (Securities Markets Programme)
- Carried out Very Long-Term Refinancing Operations (VLTROs)
- Announced conditional Outright Monetary Transactions
(OMT) in secondary sovereign bond markets
Why did the ECB took the measure to install a negative interest rate on the deposit facility?
To address the onset of a credit crunch and the risk of deflation.
What is meant by “Forward Guidance” by the ECB?
Communicating how the ECB expects its policy measures to
evolve in the future and what conditions would warrant a change in the policy stance.
Why did the ECB start an “Asset Purchase Programme”?
To put
downward pressure on the term structure of interest rates
What was the TLTRO designed for?
Designed to support bank lending to businesses and households
What was the Pandemic Emergency Purchase Programme (PEPP) designed for?
A temporary asset purchase programme of private and public sector securities to counter the serious risks posed by the coronavirus outbreak
Why did central banks establish macroprudential policy frameworks?
The global financial crisis showed that countries need to contain risks to the financial system
as a whole with dedicated financial policies.
Why are centralbanks suited for macroprudential policy?
Central banks are well placed to conduct macroprudential policy because they have the capacity to
analyse systemic risk. In addition, they are often relatively independent and autonomous.
Why are centralbanks suited for macroprudential policy?
Central banks are well placed to conduct macroprudential policy because they have the capacity to
analyse systemic risk. In addition, they are often relatively independent and autonomous.
What are the advantages of non-conventional tools for monetary policy?
Non-conventional tools have been powerful in directly influencing borrowing conditions of the
private sector, and they have been instrumental in stimulating growth and inflation during the past periods of financial and economic stress
What are the disadvantages or risks of non-conventional tools for monetary policy?
The unconventional measures carry risks and have significant distributional consequences.
They appear to have contributed to an underpricing of risk, supporting the formation of asset price bubbles and fostering a disconnect between financial markets and the real economy.
What is targeted by the “Price stability mandate” from the Fed?
Average inflation rate of 2%
Moderately above 2% is tolerated to offset periods of below 2%-inflation
What is the aim of the “Price stability mandate” from the Fed?
Aims at increasing the Fed’s margin
for manoeuvre and allows the central bank to raise key interest rates later in the current cycle.
What is the aim of the “Employment mandate” from the Fed?
Under the previous framework, in
contrast, the Fed feared inflationary pressures that could emerge from the labour market
when the economy was in full expansion. In practice: the Fed is now prepared to let the labour market run hot but will quickly act if it is too cool.
The change follows the lower sensitivity of inflation to
unemployment
How has the primary mandate of price stability by the ECB changed?
Inflation target at 2%, neg and pos deviations are equally undesirable
Forward guidance, asset purchases and longer-term refinancing remain an integral part of the toolkit
HICP will remain, with inclusion of costs related to owner-occupied housing as a multi-year project
Ambitious climate-related action plan
How do climate-related events increase overall economic volatility?
Climate-related events are often permanent supply shocks. They create a trade-off by the central bank between stabilising inflation and economic growth
How do climate change affect policy stances?
Most climate-related shocks are likely
to be relatively persistent. In contrast to temporary shocks, more permanent shocks give
central banks less room to remain on the sidelines.
What is a fully fledged digital currency?
Central Bank Digital Currency or CBDC: the digital
equivalent of cash, i.e. a direct claim on the central bank
What is the difference between CBDC and private digital currencies?
Private digital ‘currencies’ such as Bitcoin are not fully-fledged currencies. Bitcoin is not a debt claim against anyone and is not backed by a central bank or any other body that watches over the value of the money
Why does a CBDC have intrinsic value?
A CBDC, like its physical
counterpart cash, does indirectly have an intrinsic value through its status as legal tender. At
the very least, the user is certain of being able to use it to pay his or her tax debt to the
government.
What are some of the reasons why central banks are studying the concept of digital currency?
1) to ensure the security and robustness of the payment system
2) promote the efficiency of the domestic and international payment system
3) financial stability in its broad sense, it is about protecting
the autonomy and sovereignty of monetary policy within the domestic economy
What is MMT?
Modern Monetary Theory
Where does the principles of MMT come from?
It is a forerunner of the concept of fiat money: money has no intrinsic value, but derives it from the fact that it is a legal tender and that it is necessary to pay taxes owed to
the government.
What is the central policy instrument of MMT?
The budget balance is the central policy instrument used to stabilise the business
cycle around an unemployment rate target
What does MMT suggest to keep inflation under control?
To keep inflation under control, MMT proposes to remove any excess liquidity from the economy by means of extra taxes or bond issuance to private
investors
What is the most important task of monetary policy regarding the budget balance?
The task of monetary policy is solely to (fully) finance any deficits that may occur by creating money
What are two concerns regarding MMT?
Central bank becomes part of the Ministery of Finance: If monetary policy is eliminated as a policy instrument, the
government is severely constrained in being able to achieve its macroeconomic objectives
simultaneously.
The MMT attributes the role of pursuing price stability to
fiscal policy
