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Monetary Policy SFLS
- 1. Introduction to MonetaryPolicy
- 2. Introduction to MonetaryPolicy 3.) How Banks make Money 1.) Goals and Types of Monetary Policy 2.) Tools of Monetary Policy 4.) Monetary Policy Limitations
- 3. Monetary Policy AD =C + I + G + (X – M) - is the use of targeting inflation, interest rates, and the exchange rates to shift the AD curve. Reworded definition: 换句话说 - is the use of changing the supply of money to sustain economic growth and smooth 连出 the business cycle. 1.) Goals and Types of Monetary Policy
- 4. - An increasein the money supply to increase AD Expansionary Monetary Policy AD = C + I + G + (X – M) Inflationary Monetary Policy or Definition with arrows: 换句话说 ***Ceteris Paribus Money Supply Shifts AD right 1.) Goals and Types of Monetary Policy
- 5. AD = C+ I + G + (X – M) Contractionary Monetary Policy Deflationary Monetary Policy or Money Supply ***Ceteris Paribus Definition with arrows: 换句话说 Shifts AD left - An decrease in the money supply to increase AD Expansionary Monetary Policy 1.) Goals and Types of Monetary Policy
- 6. Time Long Run Short Run Econ Growth UseContractionary Monetary Policy Use Expansionary Monetary Policy Monetary Policy - is the use of changing the supply of money to sustain economic growth and smooth 连出 the business cycle.
- 7. Time Long Run Short Run BusinessCycle Econ Growth Monetary Policy - is the use of changing the supply of money to sustain economic growth and smooth 连出 the business cycle. - Basically, monetary policy aims to stabilize economic growth, avoiding a boom and bust economic cycle.
- 8. Introduction to MonetaryPolicy 1.) Goals and Types of Monetary Policy 2.) Tools of Monetary Policy 3.) How Banks make Money 4.) Monetary Policy Limitations
- 9. 1.) Reserve Requirements(rr) 2.) Interest Rates (ir) 3.) Open Market Operations (omo) 4.) Exchange Rate Controls (Forex controls) 5.) Quantitative Easing (QE) 2.) Tools of Monetary Policy AD = C + I + G + (X – M) How the Tools of Monetary Policy work (PED > 1)
- 10. AD = C+ I + G + (X – M) Money Supply Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 ***(PED > 1) 1.) Goals and Types of Monetary Policy - More money mean more possible transactions and investment in the economy, however can lead to inflation.
- 11. 1.) Reserve Requirements (rr) - theminimum fraction of customer deposits that each commercial bank must hold as reserves. (rather than lend out). Definition with arrows: 换句话说 ***Ceteris Paribus the (rr) 2.) Tools of Monetary Policy Money Supply Shifts AD right
- 12. Liabilities Assets $100 Let’s saythe (rr) is 10% percent (rr) Let’s say people deposit $100 in the bank The bank can make lots of loans and increase the money supply a lot 10% Cannot be lent out loans + $90 2.) Tools of Monetary Policy – Reserve Requirements 90% Can be lent out Reserve Requirements - the minimum amount banks have to keep in the bank and can’t lend out. (rr) MS AD= $100
- 13. Let’s say the(rr) is 40% percent (rr) 60% Cannot be lent out loans 2.) Tools of Monetary Policy – Reserve Requirements 40% Can be lent out Reserve Requirements - the minimum amount banks have to keep in the bank and can’t lend out. (rr) MS AD= The bank can make lots of loans and increase the money supply by a smaller amount Liabilities Assets $100 Let’s say people deposit $100 in the bank $100 + $40
- 14. 2.) Interest Rates (ir) -The main rate charged to commercial banks from the central bank. Definition with arrows: 换句话说 ***Ceteris Paribus the (ir) (discount/base rate) Discount Rate What it is called in the US Base Rate What it is called in the UK 2.) Tools of Monetary Policy Money Supply Shifts AD right
- 15. - benchmark ratethat some of the world's leading banks charge each other for short-term loans. (inter-bank) the inter-bank rate Federal funds rate What it is called in the US Libor What it is called in the UK 2.) Tools of Monetary Policy 2.) Interest Rates (ir) Definition with arrows: 换句话说 ***Ceteris Paribus Money Supply Shifts AD right
- 16. 2.) Tools ofMonetary Policy – Interest rates - The central bank rate can control all the other banks rates Discount Rate or Base rate - Rate the central bank charges to the commercial banks - Rate banks charge to each other Federal Funds Rate or Libor (only to be used in uncommon times) (more commonly used rate) 5% 6% 6% 8% 8% 8% central bank commercial banks Bank customers
- 17. 2.) Tools ofMonetary Policy – Interest rates - The central bank rate can control all the other banks rates Discount Rate or Base rate - Rate the central bank charges to the commercial banks - Rate banks charge to each other Federal Funds Rate or Libor (only to be used in uncommon times) (more commonly used rate) central bank commercial banks Bank customers Let’s say the central bank lowers it’s rate 2% 3% 3% 5% 5% 5% Means lowers rates for I in AD so more investment spending MS = AD
- 18. 3.) Open Market Operations(OMO) buying securities - buying and selling government securities in an attempt to control interbank interest rates. - ( libor –UK) - ( federal funds rate – US) 2.) Tools of Monetary Policy Definition with arrows: 换句话说 ***Ceteris Paribus Money Supply Shifts AD right
- 19. 2.) Tools ofMonetary Policy - OMO - buying and selling government securities in an attempt to control interbank interest rates. MS AD= Central bank goes out into the market and buys bonds and securities… in exchange for liquid money. central bank Investors are commercial banks New money can now be lend out or used for consumption.
- 20. 4.) Exchange Rate controls (FOREXcontrols) increase Depreciation - Managing the use of the countries money between countries. 2.) Tools of Monetary Policy Definition with arrows: 换句话说 ***Ceteris Paribus Money Supply Shifts AD right
- 21. Marvel Land DC Land Marvel Land Money DCland Money (Country B)(Country A) FOREX graph example D from B D from A S from B S from A A money = more valuable B/A A/B B money = less valuable Appreciation in other country Depreciation in this country NX AD==Depreciation
- 22. 5.) Quantitative Easing (QE) buyingsecurities - Buying and selling more types of securities. - used by central banks to stimulate the economy when standard monetary policy has become ineffective. 2.) Tools of Monetary Policy Definition with arrows: 换句话说 ***Ceteris Paribus Money Supply Shifts AD right
- 23. 2.) Tools ofMonetary Policy - QE - The same idea and OMO, but now the bank just buys even more different types of securities. MS AD= Central bank goes out into the market and buys bonds and securities… in exchange for liquid money. central bank Investors are commercial banks New money can now be lend out or used for consumption.
- 24. Introduction to MonetaryPolicy 3.) How Banks Create Money 1.) Goals and Types of Monetary Policy 2.) Tools of Monetary Policy 4.) Monetary Policy Limitations
- 25. - banks keepa fraction of deposits as reserves and use the rest to make loans. The central bank of a country establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits. The reserve ratio, (rr) = fraction of deposits that banks hold as reserves = total reserves as a percentage of total deposits fractional reserve banking system, 部分准备 金银行制度 Excess reserves are bank reserves over and above its required reserves. 3.) How Banks Create Money
- 26. Liabilities Assets $100 Reserves (rr) deposit 10%Cannot be lent out loans + $90 90% Can be lent out 3.) How Banks Create Money T-account: a simplified accounting statement that shows a bank’s assets & liabilities. Example: Banks’ liabilities include deposits, assets include loans & reserves. In this example, notice that (rr) = $10/$100 = 10%. $100
- 27. An Example with3 different situations: Suppose $100 of currency is in circulation. To determine banks’ impact on money supply, we calculate the money supply in 3 different cases: Case 1. No banking system Case 2. 100% reserve banking system: banks hold 100% of deposits as reserves, make no loans Case 3. Fractional reserve banking system 3.) How Banks Create Money
- 28. CASE 1: Nobanking system Public holds the $100 as currency. Money supply = $100. 3.) How Banks Create Money No banks… no increase in the money supply…
- 29. Liabilities Assets $100 Reserves (rr) deposit 100%Cannot be lent out $100 3.) How Banks Create Money CASE 2: 100% reserve banking system Public deposits the $100 at First National Bank (FNB). Money supply = currency + deposits = $0 + $100 = $100 In a 100% reserve banking system, banks do not affect size of money supply. Banks can’t make loans… no increase in the money supply…
- 30. Liabilities Assets $100 Reserves (rr) deposit $10Cannot be lent out $100 +90 3.) How Banks Create Money CASE 3: Fractional reserve banking system Suppose rr = 10%. Banks loans all but 10% of the deposit: loans $90 Can be lent out
- 31. Liabilities Assets $100 Reserves (rr) deposits $9Cannot be lent out $100 +90 3.) How Banks Create Money Suppose rr = 10%. Banks loans all but 10% of the deposit: Loans + Reserves $81 Can be lent out CASE 3: (Continued..) Fractional reserve banking system Assets $90 deposits +81 Liabilities Loans + Reserves $90
- 32. Liabilities Assets $100 deposits $8.10 Cannot be lentout $100 +90 3.) How Banks Create Money Suppose rr = 10%. Banks loans all but 10% of the deposit: Loans + Reserves $72.90 Can be lent out CASE 3: (Continued..) Fractional reserve banking system Assets $90 deposits $90 +81 Liabilities Loans + Reserves Assets $81 deposits +72.90 Liabilities Loans + Reserves $81
- 33. The process continues,and money is created with each new loan... Original deposit = 1-bank lending = 2-bank lending = 3-bank lending = ... $ 100.00 $ 90.00 $ 81.00 $ 72.90 ... Total money supply = $ 1000.00 3.) How Banks Create Money In this example $100 or reserves generates $1000 of money Known as the Money Multiplier CASE 3: Fractional reserve banking system 部分准备金银行制度 ***A fractional reserve banking system creates money, but not wealth.
- 34. The Credit multiplier= 1/rr. In our example, rr = 10% money multiplier = 1/rr = 10 $100 of reserves creates $1000 of money Credit multiplier or Money multiplier - the amount of money the banking system generates with each dollar of reserves. 3.) How Banks Create Money
- 35. Introduction to MonetaryPolicy 3.) How Banks Create Money 1.) Goals and Types of Monetary Policy 2.) Tools of Monetary Policy 4.) Monetary Policy Limitations
- 36. At some pointit stops being effective.
- 37. 4.) Monetary PolicyLimitations A common expression about it is called, “pushing on a string”
- 38. Liquidity Trap 4.) MonetaryPolicy Limitations - injections of cash into the private banking system by a central bank fail to decrease interest rates and hence make monetary policy ineffective. Money Supply Shifts AD rightLower interest rates *** Only leads to more inflation
- 39. Liquidity Trap DiscountRate or Base rate Federal Funds Rate or Libor central bank commercial banks Bank customers Once the rate gets to 0% it’s not working to stimulate any more growth. 0% 0% 0% 0% 0% 0% Reached the end of this tool and I in AD is not increasing with the lower rates. Now what? 4.) Monetary Policy Limitations – Liquidity Trap
- 40. 4.) Monetary PolicyLimitations Monetary policy can’t really help this problem.
- 41. Price level GDP AD SRAS PE LRAS YN SRAS1 Y1 P1 2.) Cost-Push Negative supply shock 4.)Monetary Policy Limitations The bad kind of inflation because it involves lower output. Monetary policy can’t really help this problem, it only adds to inflation.
- 42.
- 43. Price level GDPY AS Aggregate Supply is:AggregateSupply is: Classical zone Economy’s resources already are fully used so only prices increase. Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations Where you are on this curve matters how effective the policies can be.
- 44. Price level GDPY Aggregate Supply is: Classicalzone Economy’s resources already are fully used so only prices increase Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations AD AD1 Can be very effective here... AS
- 45. Price level GDPY Aggregate Supply is: Classicalzone Economy’s resources already are fully used so only prices increase. Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations AD AD1 Can be effective here, but watch out for inflation. AS
- 46. Price level GDPY Aggregate Supply is: Classicalzone Economy’s resources already are fully used so only prices increase. Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations AD AD1 AS No longer effective now, you just have inflation.
- 47.
- 48. AD = C+ I + G + (X – M) Money Supply Price level GDP AD SRAS PE LRAS YN Y1 P1 AD1 ***(PED > 1) 1.) Goals and Types of Monetary Policy - More money mean more possible transactions and investment in the economy, however can lead to inflation.
- 49. 1.) Reserve Requirements(rr) 2.) Interest Rates (ir) 3.) Open Market Operations (omo) 4.) Exchange Rate Controls (Forex controls) 5.) Quantitative Easing (QE) 2.) Tools of Monetary Policy AD = C + I + G + (X – M) How the Tools of Monetary Policy work (PED > 1)
- 50. - banks keepa fraction of deposits as reserves and use the rest to make loans. The central bank of a country establishes reserve requirements, regulations on the minimum amount of reserves that banks must hold against deposits. The reserve ratio, (rr) = fraction of deposits that banks hold as reserves = total reserves as a percentage of total deposits fractional reserve banking system, 部分准备 金银行制度 Excess reserves are bank reserves over and above its required reserves. 3.) How Banks Create Money
- 51. The Credit multiplier= 1/rr. In our example, rr = 10% money multiplier = 1/rr = 10 $100 of reserves creates $1000 of money Credit multiplier or Money multiplier - the amount of money the banking system generates with each dollar of reserves. 3.) How Banks Create Money
- 52. 4.) Monetary PolicyLimitations
- 53. Price level GDPY AS Aggregate Supply is: Classicalzone Economy’s resources already are fully used so only prices increase. Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations AD AD1
- 54. Price level GDPY AS Aggregate Supply is: Classicalzone Economy’s resources already are fully used so only prices increase. Intermediate zone Increase in GDP can lead to an increase of inflation too. Keynesian zone So an increase in GDP wouldn’t mean an increase in inflation. 4.) Monetary Policy Limitations AD AD1
- 55.