Topic 14- Monetary Policy Flashcards
Monetary Policy
actions the central bank takes to manage the money supply and interest rates to aciheve macroeconomic goals
what are the goals of central bank
1) price stability (during inflation/deflation)
2) high employment
3) stability of financial markets and institutions (lender of last reesort)
what is high employment
low unemployment
what does high unemployment indicate
economy is below the natural elvel of outpu
resources arent being used effectively (even human resources)
recall the monetary policy tools
open market operations
lending to financial institutions
changing reserve ratio
can central bank affect inflation rate directly?
no! they ise monetary policy tools to afhust the money supply and the interst rate
assumptions about the money market
1) two financial assets only:
-money: liquid and used for transaction but pays no interest
-bonds: illiquid and not used for transaction but pay positive interest rate (i)
How do you determine the amount of money you should hold vs the amount of bonds you hold
1) the level of transactions
2) the interest rate on bonds
What is level of transactions
How often consumers spend money basically
higher income implies more transactions and hence higher demand for money
why would you rather hold bonds than money
if interst rate is higher then you would rather hold bonds!
HIGHER INTEREST RATE IN MONEY MARKET, SHOULD YOU KEEP BONDS OR MONEY
means there is a higher oppprotuntiy cost for not having bonds/keeping money
so YOU HOLD LESS MONEY AND MOREEEE BONDS
thats why money demand curve is downward sloping@
what is the demand curve in the money market
the QUANTITY OF MONEY money people hold
what causes money demand curve to shift
-> this depends on total income in the economy (gdp)
so:
a) the price level (INFLATION)
b) the real gdp (which is equal to total incomes)
what causes a movement ALOOOONG the demand curve
CHANGES IN INTEEREST RATE <3
THIS IS MEASURED IN THE Y AXIS
what is the money supply cruve look like
a vertical line, because it depends solely on the central bank (not on interest rate)
theory of liquidity preferecne
the interest rate adjusts to balance the supply and demand for money
Basically that the interest rate is what helps find equilibrium in the money supply (vertical line) and money demand (downward sloping like) curves in money market
how does money supply increase
through OPEN MARKET OPERATIONS!!
when central bank BUYS government bonds: increases money supply
when central bank SELLS government bonds: decreases money supply
what does open market operations impact in money market
affect money supply, which will OBVIOSULy influecne interest rate
Move money supply (vertical curve) to the right, decreases interest rate (because the Demand curve is held ocnstant)
what would happen if central bank only adjusted the overnight interest rate instead of open market operations
temporary fix, money supply would go back to eequilibrium, affects long term int rates but mostly short term
(movement along the x🤣curve)
changing money supply will SHIFT THE CURVE
what is more effective in moving interest rate, change in money supply or change in overnight interest rate
overnight interest rates: affects both long term and short term interest rates, but more emphasis on short
Money supply: has longer lasting impacts
Why would bank of canada want to decline output
Because they want to focus on price stability, during peirods of high output and production, there is also HIGH INFLATIOON!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!!
when central bank BUYS government bonds:
INCREASES MONEY SUPPLY
when central bank SELLS government bonds:
decreases money supply
when central bank DECREASES MONEY SUPPLY WHAT HAPPENS
iterest rates rise
when central bank INCREASES MONEY SUPPLY
interest rates decreaiases
How does high interest rate affect AD:
AD CURVE SHIFT LEFT
Consumption: DECREASE THE amount people want to spend, higher cost of durable goods
G: N/A
I: Decreases Investments, more expensive to borrow for firms
NX: Decreases exports because people dont want to buy from somewhere with high interest rates, MORE IMPORTS
How does LOW interest rate affect AD:
AD CURVE SHIFT RIGHT
Consumption: increases the amounts of goods people buy, increase durabel good spending,
G: N/A
I: Increases Investments, LESS expennsive to brrow from banks, when int rates on mortgage loans fall, more investment
NX: Increases exports because people WANNA BUY WHERE INTEREST RATE IS LOW!! MORE EXPORTS
When interest rates decrease, a intnderest rates on mortgage loans fall, more new homes will be
purchased by households
what will this do
=⇒ investment increases
AD CURVE RIGHT
what happens during a recession
short run equilibrium (intersection of AD curves and SRAS curve) happens below natural level of production
UNEMPLOYMENT IS SO HIGH
How does BoC decrease unemployment?
exansipirary fiscal policy, INCREASE MONEY SUPPLY BY BUYING BONDS, lower the interest rate, lower int rates shift AD CURVE RIGHT
REAL GDP AND PRICE LEVEL RISE
How does BoC cool an overactive economy
contractionary fisal policy, decrease money supply by selling bonds, money supply decreaes, interest rate rises, AD CURVE shift left
REAL GDP AND PRICE LEVEL FALL
When economy in expansion, what does BoC employ
contractionary policy
when ecnomy in recession what does BoC emply
exapsnionary ppolicy
why would BoC ever use contractionary poicy? Make output decline?
in the long run it is unsutaibale, because it would result in rising inflation
THIS IS PRICE INSTABITLIY
wHAT is the long run impact of contractionary monetary policy
gdp and price level fall
wHAT is the long run impact of expansioarnyr monetary policy
real gdp and price level rise
BASIACLLY, IF THE MS VERTICAL CURVE SHIFT RIGHT
THE INTEREST RATES WILL FALL ON THE MS DEMAND CURVE, AD CURVE SHIFT RIGHT, EXPANSIONARY POLCIY, HIGHER LEVEL OF GDP AND PRICE LEVEL
BASICALLY, IF THE MS VETICAL CURVE SHIFT LEFT
THE INTEREST RATES WILL RISE ON THE MS DEMAND CURVE, AD CURVE SHIFT LEFT, CONTRACTIONARY MONETARY POLICY, LOWER LEVEEL OF GDP ADN PRICES LEVEL
