(Topic 4) Monetary Policy And Interest Rate Determination Flashcards
According to the Central Bank’s Balance Sheet, what would be their assets?
What are their liabilities?
Assets:
- Government securities
- Discount loans (to Financial Institutions)
Liabilities:
- Currency in circulation
- Reserves
Why do banks have an account at the central bank?
To hold deposits.
What is a reserve ratio?
The portion of deposits banks must hold in cash.
How does the central bank inject reserves into the banking system?
- Open market operations
- Loans to banks, referred to as discount loans
What are the monetary liabilities of the central bank?
- Currency in circulation (C)[physical currency in hands of the public]
- Reserves (R)[bank deposits with CB]
B = C + R
________ = currency in circulation + total reserves in the banking system
Monetary base (B)
What are the monetary assets of the central bank?
- Government securities (T-bills and bonds)
- Loans to financial institutions (to member banks at current lending rate)
- Open market operations (buy/sell gov securities) and discount lending (extension of loans to banks)
The effects of an open market purchase on reserves depends on whether the seller of the securities keeps the proceeds from the sale in ______ or in ______.
In currency or in deposits.
The effects of an open market purchase on the monetary base always ________ the monetary base by the amount of the purchase.
Increases.
What factors determine the money supply?
- Changes in the non borrowed monetary base (MBn) [+ve related]
- Changes in borrowed reserves from the CB (BR) [+ve]
- Changes in required reserves ratio (rr) [-ve]
- Changes in currency holdings (cr) [-ve]
- Changes in excess reserves (er) [-ve]
What is the overnight interbank interest rate?
What affects it?
Interest rate on loans of reserves from one bank to another (for overnight loans).
Open market and discount lending are major tools, but reserve requirements can also affect the rate.
What is the federal funds rate?
The interest rate at which depository institutions actively trade balances held at the Federal Reserve, called federal funds, with each other, usually overnight, on an uncollateralised basis.
What are excess reserves?
Insurance against deposit outflows.
The facility at which banks can borrow reserves from the Federal Reserves is called the _______ ______.
The discount window.
The Fed’s discount loans policy is primarily of three types, what are they?
- Primary Credit (healthy banks rate allowed to borrow at very short maturities from primary credit facility)
- Secondary Credit (given to troubled banks with liquidity problems)
- Seasonal Credit (for small, regional banks that have seasonal patterns of deposits)
What is discount lending also used for?
- Lender of last resort (to prevent bank panics)
Which goals of the central bank conflict?
- High employment + growth/inflation
- Stability of interest rates
What is an anchor?
A key indicator that guides our monetary policy (IRS, inflation, total money supply)
They’re useful for:
- Managing expectations (transparency)
- Avoid time inconsistency problem - day to day monetary policy less likely to perform poorly/miss targets
What is inflation targeting?
An aim to keep short-term inflation within a certain range.
What are the advantages of inflation targeting?
- Easy to understand
- It forces policy makers to communicate goals and discuss progress regularly (provides transparency and accountability)
- Helps avoid the time inconsistency proves since the public can hold the central bank accountable to a clear goal
What are the disadvantages of inflation targeting?
- Signal of progress is delayed
- Promotes rigidity
- Can increase output fluctuations
- Usually accompanied by low economic growth
According to the long-run Phillips curve, which goals no longer conflict?
Unemployment and inflation.
When there is a financial crisis, there are two major reasons that could lead to a failure of conventional monetary policy.
What are they?
- The financial system freezes, hence very limited capital flows (transmission mechanism breaks)
- There is a zero lower bound, i.e. interest rates fall and cannot be reduced further (could take rates close or even below zero)
How does unconditional monetary policy address the issues that stem from a failure of conventional monetary policy?
- Provides more liquidity (an expansion of money base)
- Buys more assets (especially illiquid ones)
- For example, quantitative easing
What are the three types of money demand?
- Transactions demand
- Speculative demand
- Precautionary demand
The transaction demand for money is assumed to be ________ related to income.
Positively
Mt = f(Y)
Demand to hold speculative balance is _________ related to interest rates.
Negatively
Msp = f(r)
Policymakers must establish a nominal anchor which defines price stability.
What is the role of a nominal anchor?
A single nominal variable, such as the inflation rate or the money supply, which the central bank uses to pin down the price level to achieve price stability.
What is the time-inconsistency problem?
The idea that day-by-day policy decisions lead to poor long-run outcomes.
Price stability is the primary goal of most central banks, what are it’s other goals? (5)
- Lower unemployment
- Economic growth
- Stability of financial markets
- Interest-rate stability
- Foreign exchange market stability
What is the difference between hierarchical and dual mandates?
Hierarchical mandates put the goal of price stability first, and then say that as long as it is achieved other goals can be pursued.
Dual mandates are aimed to achieve two coequal objectives: price stability and maximum employment (output stability)
What are the tools of the central bank?
- Open market operations
- Discount policy
- Reserve requirements
- Interest on reserves
- Large-scale asset purchases
What are the policy instruments used by the CB?
- Reserve aggregates
- Interest rates (short-term such as federal funds rate)
