*Importance of bonds and interest rates in the macro economy. *Structure of interest rates in Sri Lanka *Current interest rate environment *Relationship between interest rates and bond prices *Importance of interest rates and bonds in setting monetary policy

1. Macro Economics – Bonds and Interest Rates
Eng. Dhanushka Dissanayake

2.  The monetary policy maintains critical role in the economy.
It empowers the monetary intermediation process which
encourages the stream of assets among savers and
borrowers.
 Along these lines guaranteeing that budgetary assets are
assigned proficiently towards advancing financial
development and advancement.
 Monetary dependability is the nonattendance of
unreasonable changes in the macro economy. An economy
with genuinely consistent yield development and low and
stable expansion would be viewed as monetarily stable.

3. Understanding the
 Importance of bonds and interest rates in the macro
economy.
 Structure of interest rates in Sri Lanka
 Current interest rate environment
 Relationship between interest rates and bond prices
 Importance of interest rates and bonds in setting
monetary policy

4.  Objectives of Central Bank :
Maintaining economic and price stability
Maintaining financial system stability
Monetary Policy
 Why Monetary Policy?
◦ Inflation vs Deflation
 How Monetary Policy Achieves Price Stability?
◦ Setting Policy Interest Rates
◦ Managing Liquidity in the Economy

5. Policy Instrument
•Policy Rates
•Open Market Operation
•Reserve Requirements
•Bank Rates
Operating
Target
•Average Weighted
call Money Rate
Intermediate
Variable
• Broad money
Supply
Economic and
Price Stability

6.  Policy Instruments
Standing Deposit Facility Rate– 7.2%
Standing Deposit Lending Rate – 8.75%
Open Market Operations –
Control Money Supply Through Securities
Statutory Reserve Requisition – 7.5%
Bank Rate – 15%
 Operating Target –
Average Weighted Call Money Rate
Controls by SDFR and SLFR
 Intermediate Variable – Broad Money Supply
 Final Objective - Economic and Price stability

7.  Financial system stability can be characterized as the
capacity of the budgetary framework to perform easily its
key capacities.
 for example, intermediation of monetary assets, the board
of dangers, and settling of installments, effectively,
consistently, incorporating into the occasion of unfavorable
stuns and stress circumstances.
 A stable monetary framework is one in which the
budgetary foundations and markets and the installments
framework are working viably and there is a
nonappearance of saving money, cash, installments and
repayments emergencies.

8.  Important for financial system stability as interest
rates, exchange rates and other asset prices move in
response to changes in the general price level,
impacting on the risk profile of financial institutions.
 Economic, price and financial system stability are
necessary for sustained economic growth. Hence the
two objectives are in harmony and this enables the
CBSL to perform its main functions more effectively.

9.  Three types of domestic debt securities issued by the
Government of Sri Lanka as below,
 Treasury bills
 Treasury bonds
 Sri Lanka Development Bonds

10.  Types Bonds
◦ Bond categories based on type of interest
 Fixed rate bonds
 Floating rate bonds
◦ Bond categories based on type of issuer
 Government bonds
 Corporate bonds

11. Interest Rates Bond Price
Interest Rates rise Decline
Interest Rates fall Rise
• When interest rates increment, the cost of the bonds will fall, and the
yield will increment to stay aggressive with winning interest rates.
• When interest rates are falling, the cost of the bonds will rise, and the
yield will diminish to stay focused with remaining interest rates.

12. Money
Supply
Money
DemandINEQUALITY
Interest Rate
{
M
P
}S = {
Ḿ
P
}S
{
M
P
}D = L(Y, r)
Money market interest rate is the indicator of inequality of money supply
and demand
Price Stability
Economic Growth
Monetary
Policy
Objective

13. 0
5
10
15
20
25
InterestRate%
M/P (Real Money Balance)
{
M
P
}D= L(Y, r)
{
M
P
}s
{
M
P
}
{
M∗
P
}s01
{
M∗
P
}s02
r* L1(Y1, r)
L2(Y2, r)
r1*
r2*
1,a
2
3
b
c

14. Nominal
GDP
>
Money
Supply
Deflation
Inflation<
CB increase money
supply by
purchasing bonds
and securities and
to reduce interest
rates
CB decrease money
supply by selling
bonds and
securities and to
increase interest
rates
=
*Other factors remain as constants
r
r

15.  Changes in Policy Interest Rates of the Central Bank of Sri Lanka as below
for last two decades. Data is extracted from Central Bank of Sri Lanka.
0.00
5.00
10.00
15.00
20.00
25.00
30.00
05.01.2000
11.05.2000
08.06.2000
29.09.2000
18.01.2001
02.08.2001
27.12.2001
04.04.2002
07.01.2003
13.05.2005
16.06.2006
23.02.2007
12.01.2009
22.04.2009
18.11.2009
29.04.2011
10.05.2013
15.04.2015
24.03.2017
PolicyInterestRates
SDF Rate (%)
SLF Rate (%)
Bank Rate
SRR

19.  Central bank’s main goals and the objectives
◦ Low and stable inflation
◦ Steady growth in national output
◦ Low unemployment
◦ Orderly financial markets
 Central bank conducts monetary policy
 The changes in policy framework
 Bonds
 The relationship between interest rates and bonds