Monetary policy (Topic 13) Flashcards
What is money and its functions
Money is a medium of exchange. It is anything that is generally acceptable by society in exchange for goods and services
1) Medium of exchange
Facilitates transactions, eliminating the need for barter trade
2) Unit of account
Provides a standard way to measure the value of goods and services
3) Store of value
Can be saved and used later, retaining its worth over time
4) Standard of deferred payment
Allows for future payments to be specified in monetary terms
The creation of money
The fractional reserve banking system occurs as depositors do not withdraw all their deposits at the same. Hence banks only need to hold a certain fraction of their deposits as reserves to meet the depositors’ withdrawals.
The bank can loan out the rest of the deposits (excess deposits). The loans increase the MS through the credit creation process.
(Check from tutorial
MS = ?
MS = currency in active circulation + demand deposits of the private sector
Types of reserves
1) Required reserves (RR)
The minimum amount of reserves banks are legally required to hold to back up its deposits
2) Reserve requirement ratio (RRR)
The amount by which banks have to hold depends on the RRR
RRR = RR / bank’s total deposits x 100%
3) Excess reserves (ER)
ER refers to whatever deposits banks have available to lend after setting aside the RR
MM & change in MS
MM = 1/RRR
Change in MS = IER x MM
Monetary policy
Is the discretionary control of the economy’s money supply by the MAS that is designed to affect overall performance of the economy
Monetary tools (1)
Reserve requirements
Increasing RRR
since MM is the reciprocal of the RRR, increase in RR decreases the size of MM
Banks have less ER → ability to loan money is reduced → size of MM is reduced, less money is created, MS decrease (Vise versa)
The change in RRR will not only affect MS because of the change in ER but also because of the change in the size of MM
Monetary tools (2)
Discount / bank rate
The interest rate at which the MAS stands ready to lend reserves to commercial banks
Increasing discount rate
More costly for commercial banks to borrow reserves → less aggressive about making loans → reduces size of MM → decrease MS → upward pressure on interest rates (vise versa)
Monetary tools (3)
Open market operations
Are the purchase or sale of government securities by the MAS to influence the MS
MAS sells government securities in open market →
individuals, business or banks get the government securities and MAS gets the money which are paid for with bank deposits and bank reserves →
with lower reserves, banks cut their lending → This results in a multiple contraction of the total MS and interest rates rise (vice versa)
Monetary tools (4)
Exchange rate policy
MAS buys and sells the Singapore dollars so as to ensure that the MS in the economy is just at an adequate level
When MAS buys the Singapore dollars → more of the S$ is now with MAS and no longer in circulation → MS falls → This results in an increase in ,the interest rate (vise versa)
