roles of government Flashcards
What are the 4 economic goals for any modern economy?
• avoid too much inflation
• achieve full employment
• achieve sustainable economic growth-economic prosperity
• achieve a stable currency & strong international payments
position
do banks need capital reserves to operate?
yes the reserves are set by law or convention
monetary policy
it is concerned with control of amount of money in circulation i.e. money supply & its growth
what is the purpose of monetary policy and how does it try to achieve this?
• Used (along with fiscal policy) to prevent wide swings from high peaks to low troughs in business cycles
• Monetary policy - directed at influencing level of interest rates
by targeting a base cash rate
- MP to try to stimulate economy - reduce interest rates
- Reducing interest rates should lead to better economic growth
• MP to try to slow down economic growth - increase interest
rates
Relationship between Central Banks and
Governments
- A Govt sets monetary policy & central bank implements it.
Case in NZ up to 1986. - A Govt sets monetary objectives within certain constraints -
central bank free to achieve objectives. Case in NZ now. - Monetary policy objective set in legislation - central bank free
to follow whatever course of action it sees fit to achieve
objective.
Case in Euro area & Switzerland.
what is NZ monetary policy objective?
objective under 1989 RB Act: to control inflation &
keep in band (stable prices)
who has to agree on a Policy target agreement?
Treasurer & Governor
what does OCR stand for?
Official Cash Rate
What rate does the RBNZ target?
The official cash rate (OCR)
Who controls the currency?
The RBNZ control the currency and sells (issues) cash to the banks that need it
what does RBNZ stand for?
Reserve bank of NZ
How many times a year is the OCR reviewed?
8 times a year & changes 25 bp or multiple.
what rate does the reserve bank (RB) borrow & lend at?
borrows and lends at OCR
WHAT RATE IS USED IF BANKS WANT CASH OVER NIGHT?
banks are charged interest rate 0. 50% above OCR
what is reverse repurchase agreement?
purchase of securities
with the agreement to sell them at a higher price at a
specific future date. (RBNZ)
• For the party selling the security (& agreeing to buy it
back in future-bank) it is a repo; for the party on the other
end of the transaction (buying the security & agreeing to
sell in the future) it is a reverse repurchase agreement
.
what are the Transmission Channels for monetary policy?
- Monetary policy channel
- Credit channel
- Wealth channel
- Foreign exchange channel
Monetary policy channel
- increase in OCR by RBNZ
(This is a tool of monetary policy)
Then increase in other S/T rates as price of money bid up,
usually firstly S/T money market securities rates increase
e.g. bank-accepted bills- large company borrowing.
Then costs of funds for banks so they increase deposit rates
Credit channel
- increase in OCR rise in investment risk
bank lending may fall as borrowers come under stress due to
higher interest costs so less credit available
Wealth channel
- higher interest rates decrease in asset
values loss of confidence for companies & households
decrease in economic activity
Foreign exchange channel
- rise in OCR higher exchange rate
exports may fall due to higher cost whereas import prices fall
harmful effect on balance of trade & economic output
what are the immediate effect of Monetary policy channel?
- Short term interest rates e.g. overnight rates
- Wholesale S/T interest rates
- Foreign exchange rates
what are the intermediate economic indicators Transmission Channels for monetary policy?
- money/credit- e.g. deposit rates, floating mortgage rates
- asset prices- bond and equity
- economic activity
- domestic demand
what is fiscal policy and what are the instruments of it?
• Fiscal policy is concerned with govt.’s income & spending
• Tools (Instruments of fiscal policy) are:
– taxes,
– government spending or outlays &
– transfer payments
what is a budget deficit?
where government spending > income (from
taxes & other sources e.g. interest, fees & fines)
(1) what options can a govt use if its in a recession and wants to stimulate an economy but has a budget deficit?
one option is to borrow so its expenditure (G)
increases
- Borrowing from the domestic market
- Borrowing funds from overseas markets
the other option is govt. can reduce taxes to stimulate the economy
(1) • Borrowing from the domestic market
central bank issues $100m govt bonds to borrow.
- If govt spends all funds
no change in money supply.
Increase in real gross domestic product (GDP) in short-run
If one-off borrowing, first, upward pressure on ST interest rates
(1) • Borrowing funds from overseas markets
- initially, no impact on local borrowing, then either inflationary
or growth creating (
in govt expenditure
increase in real
gross domestic product (GDP) in S/T, & likely an increase in
taxes paid) - Long term
the govt. debt has to be repaid with interest
contractionary impact on economic growth in L/T.
(1) reduce taxes to stimulate the economy
expansionary fiscal policy- consumers have more disposable income & in short-run, stimulatory fiscal policy will increase real GDP
Contractionary fiscal policy in regards to budget deficit
it could cut its
expenditure (spending) (G) overall
.- or raise taxes people will consume less as their net
disposable income drops
- or reduce transfer payments- targeted groups spend less
whatis a budget surplus?
where income exceeds expenditure:
(2) what are the govt options with a budget surplus?
• Options: Govt can retire debt or cut taxes or build up assets or
increase govt. spending.
• Impact of govt debt retirement on the economy & the financial
system depends partly on who holds the debt securities
(2)• Retirement of Govt Debt held by domestic market
interest rates may fall when govt security holders save the
money they receive & govt need for funds drop.
Also govt risk drops.
(2) • Retirement of Govt Debt held by overseas institutions
more independent policy setting regime.
Initially, no demand ↓ for domestic loanable funds no
impact on interest rates.
- But retirement of debt makes govt safer (credit rating) &
reduces need to service debt with interest so interest rates
should fall
What are some issues relating to govt debt?
• Amount of debt usually compared with GDP- actual percentage an indication of easily it can be paid back
• Preserving an efficient capital market
- Argument for
preserving the liquidity of key benchmark maturities
• The reason for borrowing the money.
- If it is borrowed for
productive purposes e.g. to invest in infrastructure, then ability to
repay may not be an issue.
what relationship do GDP and employment have?
if GDP increases then employment increases and vice versa
importance of fiscal policy?
• For countries continually running a budget deficit, risk profile of country higher, so too is interest rates, & money has to be
borrowed from mainly off-shore to fund it.
(3) functions of RBNZ?
- Monetary policy formulation(control of MS) & credit supply
- Domestic market operations
- Prudential supervision
- Depository & settlement services
- Currency
- Foreign reserves management
- Crisis management.
(3) Domestic market operations
- operating as settlement bank
for financial system. ESAS system processes settlement
accounts. - over $25.9 billion worth of daily transactions in 2014
(3) • Crisis management.
– Acting as lender of last resort for the financial system BUT
no guarantee of banks’ deposits & no deposit insurance
under usual conditions
(3) Depository & settlement
- oversight of payments system
(3) prudential supervision
supervisory role to all non-bank bank deposit
takers (NBDTs) such as insurance companies, deposit-taking
finance companies, non-deposit taking finance companies
Basel I Guidelines on capital adequacy
• Capital adequacy focused on level of credit risk with defined
capital & statement of minimum capital ratio, risk weighting of
balance sheet assets & conversion of OBS items to ‘balance
sheet equivalents’ & risk-weightings
Basel II Capital Accord Framework- 1. Definition of bank capital
(1)Tier 1 - the core capital or highest quality (lowest risk)
Characteristics: permanent commitment of funds i.e. readily
available & rank behind claims of depositors if winding up bank
e.g. • paid-up ordinary shares
• retained earnings
• current year’s earnings
• non-cumulative, irredeemable preference shares
- Basel II Capital Accord is made up of three pillars:
Pillar One- capital adequacy
- Pillar Two- supervisory review
- Pillar Three- market discipline & disclosure
Pillar 1: operational risk
- internal and external fraud
- employment practices and workplace safety
- clients, products and business practices
- damage to physical assets
- business disruption and system failures
- execution, delivery and process management
Pillar 2: Supervisory Review
•Supervisors to ensure banks have sufficient capital & to
encourage development of, and improvement of existing risk
management policies- four guiding principles
Pillar 3: Market Discipline
• Designed to reinforce market discipline in banks’ capital
adequacy
• Note NZ has been leader in this aspect- requiring banks to
disclose quarterly relevant & quantitative info relating to their
risks, & capital adequacy
two possible ways banks can increase capital ratio?
- Find more capital
- could involve rights issue, reducing dividends, raising
money through other forms e.g. non-cumulative perpetual
preference shares - Reduce assets
- selling off subsidiaries, securitisation of loans.
