3. Whatis Money
Money is anything that is generally acceptable to
sellersinexchange forgoods and services.
A liquid asset is an asset that can easily (i.e., quickly,
cheaply, conveniently) be exchanged for goods and
services.
4. Characteristics of Money
1. Medium of Exchange – Token that can be offered
as a payment forgoods.
2. Unit of Account – All goods will have a value in
money and, thus, can be used to measure all
goods
3. Store of Value – If money is to be accepted for
goods today itmusthave durable value. (Money is
an Asset).
5. Twocategories ofmoney
1.Definitive Money (sometimes known as monetary
base/narrow money): Money that can be used
immediately for transactions without conversion to
morebasic formsof money.
- Currency+Reserve accounts
2.Broad Money: A set of assets, typically some form
of bank deposit, which can be easily converted to
definitive money.
- Checking Accounts, SavingsAccounts, Liquid
TimeDepositsand CD’s
6. Broad Money vs.Narrow Money
1. Broad money hasgrownmuch fasterthannarrow
money.
2. Narrowmoney ismoney directly controlled by the
government.
3. Broad money includes money printed by
the government plusdeposits at banks.
4. Money multiplier isratioof broad money tonarrow
money.
7. WhatisMonetary Policy
I
t is the government’s decision about how much
money to supply to the economy. This means
controlling the supply of Broad Money vs. Narrow
Money.
8. Historyof Monetary Policy
Inold times,monetary policy wasmainlyfocused
tomaintainthevalue of money.
Inflationwasnota big concern
Bankof England created in 1694
During1870–1920industrializednationssetup
central banks
Monetary policy came intoquestion duringthe
great depression.
10. Loose monetary policy
I
f the Central Bank implements a loose monetary
policy (often called expansionary), the supply of
credit increases and itscostfalls.
A loose monetary policy isoftenimplemented as
an attempt toencourage economic growth.
11. Tightmonetary policy
I
fthe Central Bank allows a tight monetary policy
(often called contractionary), the supply of credit
decreases and itscostincreases.
Any nation wantsa tightmoney policy - Inorder
tocontrol inflation.
13. Goals of Monetary Policy
Price stability
GDPgrowth
Investment
Fightrecession
Exchange rate stabilization
Desired level of unemployment rate
14. How these goals are achieved by controlling
money supply?
Price Stability:forexample, price isshootingup
and wewanttocontrol it…
W e
r e d u c e
m o n e y
s u p p l y
N o w
p e o p l e
h a v e
l e s s
m o n e y
a t h a n d
S o ,
p e o p l e
b u y l e s s
a m o u n t
o f
g o o d s
D e m a n d
f o r
g o o d s
f a l l s
P r o d u c e r s
r e d u c e
p r i c e t o
m a i n t a i n
s a l e s
15. Investmentcan be induced by controlling money
supply
GDP growth:forexample, wewanttoincrease
GDP growth…
W e Now So, Demand Producers
increase people people for produce
money have buy goods more
supply more more rise goods to
money amount match
at hand of market
goods demand
16. Forexample: ourexport isreducing and wewant
toincrease it…
W e
in c r e a s e
m o n e y
s u p p l y
A s a
r e s u lt
b a n k s
h a v e
m o r e
i d l e
m o n e y
S o ,
b a n k s
r e d u c e
in t e r e s t
r a t e
C o s t o f
i n v e s t m e n t
f a l l s a n d
g o o d s
b e c o m e
c h e a p e r
E x p o r t
r i s e s
19. Open Market Operation (OMO)
Defined as thebuying orsellingof treasury bills
and bonds by the Bangladesh Bank in the
open market.
Expansionary – Bangladesh Bank buys bonds
(injects money)
Contractionary – Bangladesh Bank sells
bonds (pullsout money)
20. Characteristics of OMO
Sometimesdone fortemporary periods
Repurchase Agreement
-- BB buys
bond
withagreement tosellitback.
Matched-Sale Purchase --
BB sells
bond
withagreement tobuy itback.
Occurs at the initiative of theBB.
BBisincomplete control.
They are flexible: BB can do small or large
amounts.
They are reversible: BBcan undo policy mistakes.
Very low-key policy instrument: difficult to tell
whatBBhas done
21. Discount Rate
Defined as therate of interestcharged tobanks
thatborrowfromthe BB.
Expansionary-- BBlowersdiscount rate.
Contractionary -- BBraisesdiscount rate.
22. Characteristics of DR
Done at thediscretion of thecommercial banks
Affects interestrate structureof thecommercial
and specialized banks
DRmay influence economic activity
23. ReserveRatio (RR)
Banks are
percentage
required to maintain a certain
of their deposits in the form of
reservesorbalances withtheBB.Thispercentage
iscalled theReserve Ratio.
ExpansionaryPolicy -- BBlowersreserve
ratios.
Contractionary Policy -- BBraisesreserve
ratios.
24. Characteristics of R
R
Tooblunt-- needs tinychanges forreasonable
adjustmentsinmoney growth.
TooDisruptive-- affects all banks balance sheets.
26. Money GrowthTargeting
Thedecade of 1970swascharacterized by high
inflationand unemployment
Central banks initially pursued money growth
targeting to achieve steady growth and low
inflation
Inthisstrategycentral banks announces the rate
of growthof money forthenextone year
But in 1980s, in spite of low inflation, output and
unemployment wereunstable inUSA,UK, Canada
and Germany
27. Because, due to changing financial system,
money demand was hard to predict and,
money growth targeting was
therefore,
ineffective
A tightly regulated financial system is necessary
for money growth targeting to be successful. Tight
financial regulation isoften not possible
Specially, in the developing countries, where
financial reforms are still taking place, strict
financial regulations are not viable
28. Inflation Targeting
Central banks in many countries adopted
inflation targeting during 1990s. New Zealand was
the pioneer.
In this strategy central bank announces the
rate(s)of inflation thatitwantstoachieve over the
next year(s)
Through this announcement the central bank
signals that hitting that target in the long-run is its
numberone priority
29. the problem of
I
nflation targeting bypasses
money demand instability
Also, it helps to make central bank’s
commitments credible to the people as most of
the people understands what goal the central
bank istryingto achieve
However, success of inflation targeting depends
on how quickly the economy responds to the
policy changes
I
f the economy responds to policy changes
slowlytheninflation targeting may lose credibility
30. TheIssueofCredibility
Monetary policy has important goals for the
country
I
fthese goals are notachieved, thenoperation of
themonetary policy toolsare not effective
People do not have faith in monetary policy
anymore
Monetary policy lose credibility
Country’sdevelopment objectives fall into chaos
31. Howcan thecentral bank maintain credibility:
Appointing a “tough central banker”
In 1979, in the face of serious inflation US
President Jimmy Carter appointed Paul
Volcker, whosucceeded to curb
inflation… but failed to check
unemployment!!!
Changing central bankers’ incentives
For example, if the head of the central
bank is easy to remove s/he might want
tobe seriousabout her/his commitments
32. Increasing central bank’s independence
I
fthe central bank isindependent itmightbe free
of political influence, and hence,
might escape political pressure to increase
output and employment (say, before national
election)
33. Monetary Policy and Inflation
“Inflation is always and everywhere a monetary
phenomenon.” –Milton Friedman
Historical evidence suggests a strong link
between high growth rates in the money supply
and high inflation
Does correlation imply causality here?
Could some other variable be driving
both inflation and money growth in the
same direction?
34. Why would money growth and inflation be
related?
Inflationistheresultof too many money
chasing too few goods
When the amount of money (currency)
increases, but the number of goods does
not,thenprices must rise.
35. Hyperinflation
A period of abnormally high growthinthe cost of
living isa hyperinflation
Behind every hyperinflation isan extremely
high rate ofgrowthin money.
36. TheGerman Hyperinflation, 1921-1923
Costs of rebuilding and reparations payments
induced the Weimar government to print
more money.
As the pace of money supply growth
increased, sotoo did inflation.
Atone point prices wererisingby 4
1
%per
day
Inflation became a self-fulfilling prophecy as
people rushed to make purchases as soon as
they received any money.
Inflation only ended when confidence was
restoredinthevalue of the currency.
37. Inflationand Money: Theory
Empirical evidence suggests a causal
relationship between money growthand inflation
A theoretical linkmay be established usingthe
AD-AS model
T
he basic intuition is that increasing
the money supply will
give people more
spending power, but does not actually
increase productive capacity
As a result, prices must eventually rise to
account for increased demand without any
increase in supply
38. Increasing the money supply shifts the AD curve
right.Thisexpands output inthe shortrun,but only
prices inthelong run.
A sustained increase in the rate of money supply
growth will lead to a sustained increase in the
rate of inflation.
39. InflationisPurelya Monetary Phenomenon
Recall that we define inflation as the percentage
change in the cost of living from one year to the
next
A one timeincrease inthemoney supply will
cause prices torise(positive inflation)
An increase in the growth rate of the money
supply will cause the rate at which prices rise
(inflation)to increase
40. Supposegovernmentspending increases by 2
0
%
next year
Prices will rise next year, but the increase in
the level of government spending is only
enough toincrease prices once.
A permanent increase in the growth rate of
governmentspending could increase
inflation, but there is an upper limit on how
much the government can spend (no more
than1
0
0
%of GDP)
Similarly, temporary supply shocks can
cause prices tochange, butcannot cause
changes intherate of inflation.
41. Whydo wesee inflationarymonetarypolicy
I
fwe agree thathigh inflation isbad and that high
inflation can only be caused by expansionary
monetary policy, why would the central bank
ever choose to expand the growth rate of
money?
Demand-Pull Inflation
T
he central bank is committed to an
unemployment target below the natural rate,
leading to a continual expansion of the
money supply to push output above full
employment.
42. Cost-Push Inflation
Worker demands (or expectations of
inflation) for higher salaries raise costs,
leading to more unemployment. The central
bank expands the money supply to restore
full employment.
Government Budget Deficits
The government finances its budget deficit
by printingmore money orgetting the central
bank to buy government bonds which it then
retires.
43. BudgetDeficitsand Inflation
Thereare threewaysa government can pay for
itspurchases
Withmoney fromtaxrevenue
Withmoney borrowedfromthepublic inthe
formof bonds
Withmoney borrowedfromthecentral bank
(i.e. money printed up forthe government).
44. I
f the government finances a deficit through tax
increases or borrowing directly from the public,
thereisno change inthe money supply.
I
fthe government borrowsfromthecentral bank,
itwillcause themoney supply to increase.
A sustainedbudget deficit could lead to inflation.
Budget deficits are notable causes of inflation in
countries withshallowcredit markets.
45. Monetary Policy in Bangladesh
Until1990:
limitedrole of BB
Government directly controlled exchange
rate and interest rate
Takawaspegged against foreign currencies
Financial Sector ReformProgramstartedin1989
Strategywastotarget monetary aggregates
Free floating exchange rate was introduced in
May, 2003
Bangladesh Bank is regularly issuing Monetary
Policy Statementsince January 2006
46. Limitationsof Monetary Policy
Does not work when aggregate demand needs
to be stimulated through direct government
spending (Great Depression)
Works on the economy through indirect
channels. Therefore, often suffers from lag to
have impact
May be dominated by fiscalpolicy
Wrongpolicy may resultinsevere damage for the
economy
47. Monetary Policy vs.Fiscal Policy
I
f the goals of the two policies do not match,
development objective willbe damaged.
Example:
Suppose, Bangladesh is suffering from
high inflationand BBwantstoreduce
it.BBreduces
money supply…
But, national election is close and will be held
withina year.
So, the ruling party decides to spend more
money on safety-net programs and employment
generating activities
Accordingly, the ruling party sets its fiscal policy
sothatexpenditure goes up…
Whatwill happen?
48. Otherproblems related tomismatchof policies
I
f the government borrows too much from the
banking system, then little money is left for the
private sector to borrow.
As a result, private sector initiatives are
hampered
Thisiscalled the“crowding out effect”
Because of crowding outprivate investmentfalls
and GDP fallsas well
Inthiscase, ifthemonetary policy authority wants
to enhance private sector credit growth,
practically ithaslittleroomtodo so…
49. Government debt:
I
f the government borrows a lot, it means that at
some point of time future, the government will
have to pay substantial amount of interest when
theloan matures
I
f at that time, the government does not have
money enough to pay the interest, it might print
money forthe purpose…
Thismeans thatmoney supply willgo up
But, if the country at that time suffers from high
inflation and BB wants to control it, the
contractionary monetary policy willnot help.
50. Monetary Policy Frameworkof Bangladesh Bank
The monetary policy framework of Bangladesh Bank
identifies a logical and sequential set of actions for
designing and conducting the monetary policy. The
framework is based on credible information on the
stability of the money demand function, the money
supply process, and the monetary transmission
mechanism.
Monetary policy in Bangladesh is framed using
projected real GDP growth rate. The targeted rate of
inflation adopts Reserve Money (RM) and Broad
money (M2) as operating and intermediate targets
respectively.
51. Monetary policy consists of a set of rules that aim at
regulating the supply of money in accordance with
predetermined goals. Monetary policy is important
because it can influence economic growth, inflation,
and the balance of payments (BOP). The central
bank conducts monetary policy by using instruments
that influence the supply of money and interest rates
inthe economy.
52. T
he main policy goals of monetary policy of
Bangladesh Bank are:
Toachieve sustainable economic growth
Tomaintainprice stability
Toattain sustainableBoP
53. TheKey Playersof Money Supply Process
in Bangladesh
The key players in the money supply process as
follows:
1.The Central Bank- The government agency that
oversees the banking system and is responsible for
the conduct of monetary policy; in Bangladesh, it is
Bangladesh Bank.
2.Banks (depository money banks (DMBs)) - The
financial intermediaries that accept deposits from
individual and institutions and make loans:
commercial banks, savings and loan associations,
mutualsavings banks and credit unions.
Depositors- individuals and institutions that hold
deposits in banks.
54. Analytical Balance Sheetof theCentral Bank
Liabilities
Reserve Money
Currency
Currency held in bank
Currency in
Circulation
Deposits of DMBs
Other deposits
Asset
s Net Foreign
Assets Net
Domestic Assets
Net Domestic Credit
Net Claims on
Government Claims on
DMBs
Claims on private
sector Other items net
55. Factors DeterminingtheMoney Supply in
Bangladesh
base or reserve money -
1. The monetary
components of the R
M include currency in
circulation, currency held in banks, deposits of
DMBs and other deposits which creates the
monetary base formoney supply
56. 2. The Money Multiplier - The central bank influences
the money supply by controlling Monetary Base
(MB),reservesand required reserveratio.I
tcan be
done through controlling money multiplier,
denoted by mm, which tells us how much the
money supply changes for a given change in the
monetary base. The relationship between the
money supply, the money multiplier, and the
monetary base is described by the following
equation:
M =
mm*MB
The money multiplier mm tells us what multiple of
the monetary base is transformed into the money
supply
57. Factors affecting themoney multiplier
Based on the complex money multiplier that we have
derived above, we know that it is affected by three
factors:
a) Thecurrency-deposit ratio (C/D)
b) Theexcess reserves-depositratio (E/D)
c) Therequired reservesratio (R/D)
58. 3. BankDepositsand Credits
4. Credit tothePublic and Private Sector
5. Cash R
eserve R
equirement (CR
R
), Statutory
Liquidity Requirement(SLR)and Bank Rate
6. Interestrate and Inflation
(M2) and I
ncome
7. Government Borrowing
8. Projection of Broad Money
Velocity of Money
