Monetary Policy (4) Flashcards
What is MONETARY POLICY?
MONETARY POLICY
all actions which aim to fix, control or improve financial stability, and therefore interest rates, inflation… with the ultimate aim of promoting economic growth
they will support general economic policies which align with their ultimate goal of achieving full employment and sustainable non-inflationary economic growth
What are the benefits of financial and P stability?
- stable economic growth
- improves decision criteria - efficient allocation of resources - increased potential productivity of the economy
- reduces de “inflation premium” (what investors demand in addition to the profitability of the investment)
What are the cornerstones of the ECB strategy?
ECONOMIC ANALYSIS
- ST; MT determinants of P performance
- focus = actual activity and financial state of the economy
- real indicators, ER fluctuations, macroeconomic forecasts…
MONETARY ANALYSIS
- broader view, to confirm the indices from the economic analysis
- takes advantage of the LT link between money and P
- broad range of economic indicators
- thorough evaluation of the loan and liquidity situation
INTEREST RATE TRANSFER MECHANISM
IR
- Expectations –> Prices and Wages
- Banks Interest Rates
–> Money loans // Asset Prices // Exchange Rate –> S&D in goods market
–> Prices and Wages // Good P // Import P –> INFLATION
What are the main instruments of Monetary Policy?
- OPEN MARKET OPERATIONS: control IR, liquidity and direct MP
- Main Refinancing Operations (MRO)
temporary operations to inject liquidity weekly, with a one week repurchase agreement, implemented by NCB
(key source of financing for the loan system of the eurozone)
- Long Term Refinancing Operations (LTRO)
temporary operations to inject liquidity monthly, with a three month repurchase agreement, implemented by NCB
(additional LT refinancing to counter-parties) - Fine-tuning Operations (rare)
- Structural Operations (rare)
- PERMANENT FACILITIES: provide and absorb liquidity, control overnight IR
- Permanent Loan Facility
obtain overnight liquidity, present sufficient assets as security, no credit limit. PUNITIVE IR (higher)
- Permanent Deposit Facility
place overnight deposits with NCB. PUNITIVE IR (lower)
- HOLDING MINIMAL RESERVES: approx 1%
reserves are calculated using monthly average
reserves earn interest at the main Eurosystem R.Op.
Following the crisis, what additional financing operations beyond 3 months did the ECB develop?
- LTRO - liquidity with 3 year maturity
- Targeted LTRO
- Asset Purchases program (APP) - maintain growth and keep inflation low
Open Market Operations are carried out via auctions, how can auctions be?
FIXED RATE
ECB specifies the rate and the entities bid for an amount
VARIABLE RATE
banks can submit up to 10 bids with amount (min 1 mill) and rates.
- American or multiple rate
bids are filled according to the rates submitted (from higher to lower), banks are place independently - Dutch or single rate
bids are filled according to a single rate, the marginal rate (that used by the ECB)
What type of auction does de ECB use?
The ECB uses fixed rate auctions. The Loan is placed using REPOS: temporary operations that consist on the sale of securities with repurchase agreement.
Guarantees? two lists of acceptable assets…
LIST I - instruments that meet some homogenous conditions imposed by the ECB
LIST II - made up of the instruments proposed by each NCB
In addition any entity can use assets in any of the lists of any NCB as security for MP operations (cross-border use of collateral)
What is TARGET2?
“TRANS-EUROPEAN AUTOMATED REAL-time GROSS-settlement EXPRESS TRANSFER system”
European System of Central Banks (ESCB)’s system for euro payments.
- centralised
- based on interconnection of each countries payments system
- payments are settled individually with immediate value
- no waiting for clearing
Why is CREDIBILITY important?
KEY ASPECT FOR BUILDING PRICE STABILITY
(built and conserved over time, constant monitorization)
- influences entities expectations and the inflationary outlook
- makes one-off intervention more effective
what to do to achieve credibility?
- independence and coherence of other economic policies
- ECB must build reputation with its initiatives
requirements to achieve credibility?
- Clear, consistent message
- Unanimous opinion
- prudent decision-making
What is QUANTITATIVE EASING?
“last resort expansive MP” to increase the MS instead of lowering the IR since it cannot be reduced further in the ST. (though purchase of LT assets)
Unconventional Monetary policy which consists in buying financial assets from commercial banks and other private institutions in order to inject predetermined amount of money in the economy.
- increases reserves of commercial banks
- increases the price of the purchased assets
- decreases the yield of the purchased assets
What are the main objectives of CBs?
- P stability
- high levels of employment
- economic growth
- financial market stability
- interest rates stability
- currency market stability
WAY OUT of the downward spiral of economic activity, unemployment, deflation, asset prices and lack of credit?
LOWER IR AND IF IT IS NOT ENOUGH INCREASE THE MONEY SUPPLY
ECB creates money
- -> currency depreciation (improves competitiveness)
- -> ECB buys bonds – higher asset P (increases family wealth) and lower cost of financing (more bank loans and more consumption) –> inflation and economic growth
