Download Monetary Policy

Monetary Policy
A brief introduction
Monetary Policy
• Monetary policy is the manipulation of the money
supply and interest rate by the central bank to
influence the borrowing of money and thereby the
level of AD (via C and I)
• What is:
– Central bank?...........................
– Money?
• Any medium that is acceptable as payment for goods and services
– Interest rate?
• It is the price/cost of borrowing money which depends on length
of time of borrowing, size of loan, inflation rate, etc. (risk and
uncertainty involved with time)
– The interest rate is determined using the usual Demand
and Supply for money OR the loanable funds market
Nature of work of financial analysts and
central bank officials
How interest rate affects AD
• Changes in interest rates ultimately affect two of
the four components of aggregate demand
– Investment (I): e.g. building a new factory,
purchasing a very expensive inventory and machine
that will likely to increase future production
– Consumption (C): e.g. large purchases that require
borrowing like cars, university tuition, etc.
– Because cost of borrowing less and/or less
worthwhile to save or to put profits into savings
– BUT how interest-sensitive (elastic) is investment?
Increasing the MONEY SUPPLY
• Quantitative Easing and ways of influencing
amount of lending done by BANKS
• Equation: MV ≡ PT (or PQ or PY or Nominal
GDP)
SO will an increase in M increase in P?
YES if…………………………………………………
 MONETARIST view : Money is so “dangerous”
that central bank should only allow it to grow
at……………………………………………..
Monetary base rises to record ¥404.5 tril.
Sept 3rd 2016
Japan’s monetary base at the end of
August increased 0.1 percent from a month before to
¥404.529 trillion, hitting a record high for the ninth
straight month, the Bank of Japan said Friday.
• The growth came as the central bank continues to
supply massive funds under its ultraeasy monetary
policy.
• The monetary base is the combined balance of
currency in circulation and commercial financial
institutions’ current account deposits at the BOJ.
• Year on year, the monetary base was up 23.5
percent, the BOJ said.
•
Jiji PressTOKYO (Jiji Press) —
Monetary base in Japan
Three Models
But all have weaknesses………
Equilibrium Interest Rate and Money Supply
Loanable Funds Market
Investment
Short Term Interest Rate………..
Which D-side policy is more effective?
• Fiscal Policy
– Pro: can pull economy out of recession (e.g. Great Depression of the
1930s; after 2008)
– ability to target sectors (e.g. spending on education, infrastructure)
with some supply side effects
– Con: time lags; hard to forecast and calculate the impacts of
changes; hard to target and fine tune as AD determined by multiple
factors;
– Budget deficit if expansionary  risk of crowding out (though has
not happened in Japan)
• Monetary Policy
– Pro: quick implementation; independence from political constraints;
no crowding out; can adjust interest rate incrementally and flexibly
• Con: time lags; effective if an inflationary gap, but not so during
recession (pushing on a string) ; international impacts (effects on
exchange rates, access to foreign lending);
Summary of D-Side Macro policies
• It is difficult to achieve the desired macro-economic outcomes. One
intervention has multiple/multivariate channels & mechanisms in
affecting the various demand components and human behavior is
complex and dynamic
• During the 1980s a lots of economists studied macroeconomic
dynamics and management . But inflation/deflation, unemployment,
inconsistent GDP growth persist
• Moreover, financial crises on the scale of the 1930s Great Depression
continue to happen eg the recession after the Lehman Shock
• The two schools of thought
– Quite different on the implications on price and real GDP level
(monetarists/new classical believe expansionary policies have no
effect on real GDP, only on average prices)
– We considered only the Demand Side, also need to consider
– Supply Side Policies
• But first will study UNEMPLOYMENT & INFLATION in more depth