Week 3 - Money and monetary policy Flashcards
How do we measure money?
Range from M0 to M4
Narrow money - M0 and M1
Broad money - M2, M3 and M4
Narrow money
M0 and M1 - includes monetary base plus bank deposits which can be used for cash transactions
Broad money
M2, M3, M4 - Narrow money plus deposits requiring notice and deposits from loans created by commercial banks
Central bank
Power to print currency and influence the amount of money create by commercial banks
Commercial banks
Under license from the central bank
Create money through loans (subject to liquidity constraints set by central bank)
What can the central bank do?
Influence the money supply by changing the interest rate
Manipulate the money supply through the buying/ selling of government bonds
Change capital restrictions imposed on commercial banks through liquidity legislation - influence the broader money supply
Quantity Theory of Money
Helps us connect the monetary and real side of the economy, normally represented in different markets
Links inflation rate to growth rate of the money supply
Velocity
Speed at which the money stock circulates around the economy
Velocity of money
Rate at which money circulates around the economy
Measured by the number of times the money stock circulates in any one year
FInancial institutions
Central banks, commercial banks, non-bank financial institutions
FInancial markets
Trading equities, bonds, other financial innovations
Financial instruments
Cash instruments such as securities, loans etc…
Derivatives instruments in the form of contracts
Stocks or equities
Rights to governance and shares in profits from publicly listed companies
Bonds: T Bills or Gilts
Debts from governments and private organisations, often with a fixed income return for investors
Government GILTS
Long term government debt (5 to 50 years)
Changes in prices of GILTS affect the long term interest rate
Treasury Bills
Short term government debts (6 months to 2 years)
Changes in price of T-bills affect the short term interest rate
Cash instrument
Cash deposit or loan that can be transferred as a security between financial entities
Derivative instrument
A security derived from a ‘group’ of assets such as loans, stocks, bonds, commodities (e.g. Futures, Structured Finance and Options)
Collateralised Debt Obligations (CDO)
Structured financial instrument that pools together different debt based assets that are then repackaged and sold on to investors in tranches
Form of risk splitting amongst risky assets
Senior Tranches
Higher credit rating
Higher priority for repayments in even of default with lower return
Junior Tranches
Lower credit rating
Lower priority for repayments in the event of default with higher return
