Download Monetary Policy

Monetary Policy
 Central Bank
 Eurosystem
 Monetary Policy Instruments
 Expansionary and Tight Monetary Policy
Objective of Monetary Policy
 To maintain price stability is the primary
objective of the Eurosystem and of the
single monetary policy for which it is
responsible. This is laid down in the Treaty
on the Functioning of the European Union
 The Treaty establishes a clear hierarchy of
objectives for the Eurosystem. It assigns
overriding importance to price stability.
The Treaty makes clear that ensuring price
stability is the most important contribution
that monetary policy can make to achieve a
favourable economic environment and a
high level of employment.
ECB
 The primary objective of the ECB’s
monetary policy is to maintain price stability.
 Definition of price stability: a year-on-year
increase in Harmonised Index of Consumer
Price (HICP) for the euro area of below 2 %.
Central Bank
 Some central banks are closely controlled
by the government in power, other central
banks have more independence.
 Central bank independence removes the
central bank from short-run political
pressures.
Central Bank
 The central bank has a number of policy
instruments that can effect the major
objectives of monetary policy:
– Stability of prices
– Stability of exchange rate
Monetary Policy
 Central banks can focus on:
– Quantitative monetary policy: central banks
regulate monetary base
– Qualitative monetary policy: central banks
regulate market interest rate and provide monetary
base which respond to money demand
Quantitative Monetary Policy
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Qualitative Monetary Policy
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Monetary Policy Instruments
 Direct, administrative instruments:
– Credit limits
– Interest rates limits
– Liquidity rules
– Investment regulation
Monetary Policy Instruments
 Indirect, market instruments:
– Open - Market Operations
– Legal Reserve Requirements
– Discount Rate Policy
Open - Market Operations
 Open-market operations represent
purchases or sale of government securities
and treasuries to influence the money
supply.
 These operations are a central bank the
most important stabilizing instruments.
Eurosystem’s open market
operations
 Open market operations serve the purpose
of managing interest rate, the liquidity
situation in the market and signaling the
stance of monetary policy.
 Eurosystem’s open market operations are
divided into four categories:
– Main refinancing operations
– Longer-term refinancing operations
– Structural operations
– Fine-tuning operations
Legal Reserve Requirements
 All banks are required to hold a minimum
percentage of deposits as reserve. Changes
in required reserve ratios can have an
important influence on the money supply.
 Changes in reserve requirements are made
sparingly because they present too large
change in monetary policy.
Minimum reserves
 The Eurosystem requires credit institutions
in the euro area to hold minimum reserves
with the national central banks. It contributes
to stabilizing of money market interest rates.
Discount Rate Policy
 Discount rate is the interest rate at which
the central bank stands ready to lend
reserves to commercial banks.
 In recent years, borrowed reserves have not
play a major role in monetary policy.
 Eurosystem doesn’t use discount rate
policy
There are the three key interest rates for the
euro area:
 The interest rate on the main refinancing
operations.
 The rate on the deposit facility, which
banks may use to make overnight deposits
with the Eurosystem.
 The rate on the marginal lending facility,
which offers overnight credit to banks from
the Eurosystem.
Expansionary Monetary Policy
 When the central bank raises the money
supply interest rates fall. The economy
moves down the money demand schedule.
Lower interest rates reduces the costs of
investment; thus higher investment raises
aggregate demand curve.
Expansionary Monetary Policy
Quantitative MP
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Qualitative MP
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Tight Monetary Policy
 Central bank contracts the money supply in
response to fears of rising prices. The
lower money supply increases interest
rates. The result of a tighter monetary
policy is lower investment and decrease in
the nation’s output.
Tight Monetary Policy
Quantitative MP
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Qualitative MP
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The Monetary Transmission
Mechanism
 The monetary transmission mechanism
represents the way by which changes in the
supply of money are translated into
changes in output, employment, prices and
inflation.
Keynesian Approach to MP
 The proximate MP objective is the
interest rate (under expansionary MP
interest rate declines). Keynesian
approach assumes high money demand
elasticity with respect to interest rate.
Effect of Expansionary MP
(unused resources)
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Effect of Expansionary MP
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Monetarist Approach to MP
(expansionary MP)
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