Money and Monetary Policy Flashcards
Define money.
Money is a token that is generally accepted in exchange for goods and services. It is a medium of exchange and is usually split between M1, M2, and M3.
Define M1.
Narrow money (M1) is the most liquid form of money and includes currency in circulation as well as overnight deposits (demand deposit accounts).
Define M2.
Intermediate money (M2) consists of narrow money (M1) as well as other less liquid forms of money. More specifically, this includes term deposit accounts (fixed accounts) that are redeemable at notice up to 3 moths and/or with agreed maturity up to 2 years.
Define M3.
Broad money (M3) is the widest definition of money, and apart from M2 it also includes very short term financial assets, refereed as marketable instruments.
Marketable instruments include repurchase agreements, money market fund shares, and debt securities (bonds) with a maturity of up to 2 years).
What are the 3 instruments of monetary policy used by the ECB to change Sm?
- Open-market operations
- Reserve requirements
- Standing facilities.
What are Open-market operations?
They are the most effective way to stimulate the economy.
Repurchase Agreements (REPOs) - if commercial banks need funds, they can sell some financial assets to other banks or to the Central Bank and repurchase them at a later stage. Therefore, if the Central Bank wants to inject more money into the economy, it will engage in REPOs, whereby commercial banks will sell their government securities to the central Bank, on the condition that they will but them back a later stage.
Reverse-REPOs - the Central Bank can sell government securities to commercial banks, with an agreement to buy them back later, thereby borrowing money from them. In this way, the Central Bank would be absorbing money out of the economy.
What are reserve requirements?
Reserve require to are central bank regulations that set a minimum amount of that commercial banks must hold in liquid assets.
For example, in 2012 the ECB made the RRR 2%, then change it to 1% due to recession. Thus, banks were able to give out more loans, so the money supply could increase to eliminate the recession.
What are standing facilities?
Standing facilities are aimed at providing and absorbing overnight liquidity - so commercial banks can meet regulations). The central bank is practicing its role as the lender of the last resort.
Overnight deposits absorb liquidity from the economy. So this will decrease the money supply.
What does Tight Monetary Policy imply?
- Lower money supply
- Increase interest rates
- Keeps inflation suppressed
- Lower availability of credit
What does Loose Monetary Policy imply?
- Higher money supply
- Decrease interest rates
- Helps to encourage investment and economic growth
- Greater availability of credit.
What are transmission mechanisms?
It is a 3 step process which shows us how monetary policy influences AD.
The process of how a change in money supply, affects interest rates, which in turn affect AD. There is an indirect relationship between Sm and AD, according to Keynes - this is because of the effect on r. Through changes in the interest rate and investment, monetary policy affects AD.
What are overnight deposits?
A bank deposit with the shortest term lasting from one calendar day to the next day. This is mainly used by banks and financial institutions. They assess their expected cash requirements from the day; borrowing money if they anticipate a shortfall or lending if they expect to have extra funds.
The overnight rate, or interest charged on these short-term loans is a crucial factor to influence money supply (standing facilities).
Mention 6 functions of the Central Bank.
- Issuer of Currency: issuance of euro bank notes and coins in accordance to rules established in the Eurosystem.
- Banker to Banks: commercial banks hold deposit accounts with the CBM.
- Banker to Government: the CBM is responsible for managing the govt’s account transactions as serves as a financial advisor.
- Lender of the Last Resort: can provide funding to commercial banks through open market operations and the marginal lending facility (provides liquidity).
- Maintaining Price Stability: the primary goal of the CBM (a symmetrical 2% inflation rate over the medium term) - helps to encourage consumption and investment.
- Economic Analysis and Research: CBM carries out analyses of domestic and international development. This helps to make sure that the Maltese economy is abiding by the Masstricht Criteria and helps in policy making.
