Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
Goals and Targets of Monetary Policy Lecture 9 Monetary policy Goals and Targets of Monetary Policy • The central banks were established to serve as a lender of last resort to commercial banks. • The central banks’ monetary tools are used to control the level of money supply or interest rate. • However, there is a several objectives which the central banks try to achieve – all of them can be potential final goal (target) for monetary policy (1) High employment • targeting the natural rate of employment, i.e. the level of employment where the demand of labor equals the supply of labor • however, estimating the natural rate of employment (or unemployment) is very difficult (2) Economic growth • - high economic growth usually leads to high level of employment • - however, economic growth and employment can be stimulated with different policies • - economic growth can be stimulated by providing companies incentive to invest in new projects • - this can be done through low interest and/or tax incentives (3) Price stability • price stability is very crucial in keeping an economy function properly • keeping prices stable also means keeping the rate of inflation stable because the rise in inflation means that purchasing power will be eroded (4) Interest rate stability • - interest rate stability is desirable because it makes borrowing and lending less uncertain for individuals and businesses • - if interest rate becomes more volatile, individuals and businesses will be less willing to borrow or lend. (5) Stability of the financial markets • the degree of development of a country is usually measured by the degree of development of its financial market • a highly sophisticated financial market eases the exchange of resources (or funds) from lenders to borrowers • an unstable financial market will slow down the transfer of such funds, which in turn will lead to slower economic growth. (6) Stability in the foreign exchange market • - the prosperity of a country depends heavily on its foreign trades and investments with other countries • - trading allows a country to specialize in certain products and services (which will lead to a higher level of output), and investments will attract funds from other countries • - however, the flow of trades and investments depends heavily on the stability of the foreign exchange market • - a volatile foreign exchange market will usually lead to a drop in foreign trades and investments. • The goals listed above can all be achieved in the long-run, but there might be some conflict in the short-run. • For example, the economy is growing which means that businesses are investing more in capitals and unemployment is falling. • However, the increase in economic activity might raise the level of inflation if insufficient goods and services are produced to meet the demand, and the level of interest rate will start rising. The ECB is the central bank for Europe's single currency, the euro. The ECB’s main task is to maintain the euro's purchasing power and thus price stability in the euro area. The euro area comprises the 16 European Union countries that have introduced the euro since 1999. Fed Building, Washington, D.C. Monetary Targets of the central banks The central banks don’t target the final goal directly. • for this purpose the central banks use a set of variables (known as intermediate targets) which have direct impacts on the central banks’ desired goals. • for example, if the CB wants to slow the economic activity (to control the economy’s inflation), it can target the monetary aggregates (i.e. M0, M1, or M4) or the interest rates (shortterm or long-term) • in this scenario, the inflation rate (and/or the economic activity) is the CB’s final monetary goal, while the monetary aggregates or interest rates are its intermediate targets FINAL GOAL (GOALS) INTERMEDIATE TARGETS – nominal anchor (monetary aggregates M1, M2, M3 ..; interest rates; exchange rate …) INSTRUMENTS (TOOLS) OF MONETARY POLICY Changes in monetary base M0 - Open market operations Discount policy Reserve requirements … • currency in circulation and the total reserves of banking system make up the monetary base (MB, monetary aggregate M0 or the primary money). MONETARY BASE (M0) 1. Currency in circulation 2. Commercial banks’ deposits into settlement accounts 3. Required reserves of commercial banks 4. Banks’ cash in vaults MB = C + R This formula shows the structure of monetary base (M0). 18 (2) + (3) + (4) = R (Total reserves of banking system) How instruments of monetary policy affects monetary base? • We can classify the monetary base (M0) into two categories: MB MB n DL where MB n Non-borrowed monetary base (open market operations) DL Borrowed monetary base, i.e. discount loans • The above formula shows the channels through which the central bank creates primary money (monetary base, M0). • Changes in the so called nonborrowed monetary base and borrowed monetary base - discount loans have also impacts on the proces of money creation. 19 EXAMPLE 1: Suppose the CB decides to buy $1,000 worth of government securities from the “AB” bank (one of commercial banks). Central bank AB bank Assets Liabilities Assets Liabilities Securities +$1000 Reserve +$1,000 Securities -$1,000 Reserve +$1,000 EXAMPLE 2: Suppose the CB made a $1,000 loan to “AB” bank through its discount window. Central bank AB bank Assets Liabilities Assets Liabilities DL +$1000 Reserve +$1,000 Reserve +$1,000 DL +$1,000 20 Total assets $4,443 billion on Nov 2, 2016 $Billions $5,000 $4,000 $3,000 $2,000 $869 billion Aug. 2007. Nov. 2008. Oct. 2010. Feb. 2013. Dec. 2014. Oct. 2016. Deposits of Depository Institutions $2,065 billion on Oct 26, 2016 kolovoz 2007. studeni 2008. listopad 2010. veljača 2013. prosinac 2014. listopad 2016. • Federal (FED) Funds … typically overnight loans between banks of their deposits at the Federal Reserve One reason why bank might borrow in the federal funds is that it might find it does not have enough deposits to meet the amount required by regulators This market is very sensitive to the credit needs of the banks, so the interest rate on these loans, called the federal funds rate, shows the tightness of credit market conditions in the banking system and the stance of monetary policy: when it is high the banks are strepped for funds; when it is low, bank’ credit needs are low The federal funds rate in a target range of ¼ do ½ percent … FINAL GOAL (GOALS) INTERMEDIATE TARGETS – nominal anchor (monetary aggregates M1, M2, M3 ..; interest rates; exchange rate …) INSTRUMENTS (TOOLS) OF MONETARY POLICY Changes in monetary base M0 - Open market operations Discount policy Reserve requirements … The relationship between the economy’s money supply (M1) and the monetary base (MB or M0): M1 m MB The money multiplier represents the impact of a $1 change in the monetary base on the economy’s money supply (M1). for example, if m = 4 that means a $1 increase in monetary base will lead to a $4 increase in the money supply MONETARY BASE (PRIMARY MONEY, M0) MONEY SUPPLY (M1) - Currency in circulation - Currency in circulation - Reserves of banking system at the central bank - Deposit money (demand deposits, transactional deposits on current and giro accounts of non-monetary agents 40 MONETARY AGGREGATES in the U.S. On March 23, 2006, the Board of Governors of the Federal Reserve System ceased publication of the M3 monetary aggregate and its components. MONEY SUPPLY (M1) M1 in the U.S. comprises: (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of other depository corporations; (2) traveler's checks of nonbank issuers; (3) demand deposits at commercial banks; and (4) other checkable deposits (OCDs), consisting of negotiable order of withdrawal (NOW) and automatic transfer service (ATS) accounts at depository institutions, credit union share draft accounts, and demand deposits at thrift institutions. M2 includes a broader set of financial assets held principally by households. M2 in the U.S. consists of M1 plus: (1) savings deposits (which include money market deposit accounts - MMDAs); (2) small-denomination time deposits (time deposits in amounts of less than $100,000); and (3) balances in retail money market mutual funds (MMMFs). New and specific monetary aggregate for the U.S. is MZM. Monetary aggregate MZM (Money Zero Maturity) is equal M2 less smalldenomination time deposits plus institutional money funds. • CB can not control the money supply and the interest rate at the same time • the reason for that is because the demand for money is out of the CB’s control. • Suppose the interest rate is estimated to be “i” and the CB has targeted to control the money supply so that it stays at Ms. • Unfortunately, since the money demand is fluctuating between Md’ and Md‘’, the market interest rate fluctuates between i’ and i’’. • As a result, when the CB wants control over the money supply, it loses control over the interest rate. Interest • Ms i M"d Md M'd Quantity • On the other hand, suppose the CB plans to target the market interest rate at i. • If the money demand remains at Md, the CB can achieved the desired market interest rate with money supply Ms. • However, since the demand for money fluctuates between Md’ and Md‘’, the CB has to constantly adjust the money supply to keep the interest rate maintain at i. • As a result, when the CB wants control over the interest rate, it loses control over the money supply. Interest M's Ms M"s • i M"d Md M'd Quantity Criteria for Choosing Intermediate Targets • The central banks have to choose either the money supply or the interest rate as the intermediate target. • What criteria does the CB use to pick its intermediate target? • The CB will pick its intermediate target based on three criteria: (i) measurability, (ii) controllability, and (iii) predictable impact on the final goal (goals). Targeting Money Supply Versus Interest Rates The unstable IS curve fluctuates between IS’ and IS’’ . The money supply target produces smaller fluctuations in output than the interest rate targets. Therefore, the money supply target is preferred. The unstable LM curve fluctuates between LM’ and LM’’. The money supply target then produces bigger fluctuations in output than the interest-rate target (which leaves output fixed at Y *). Therefore, the interest-rate target is preferred. FINAL GOAL INTERMEDIATE TARGET - The strategy of monetary policy INSTRUMENTS (TOOLS) OF MONETARY POLICY Appendix 1: Central Bank Independence. 57 Basic tasks of central banks are 1. 2. 3. 4. Formulate, adopt and control national monetary policy Manage official foreign reserves in a safe and profitable way Support and maintain appropriate payment and settlement systems Supervise national banking sector 58 • Central bank should also have high level of independence in setting instruments and goals of national monetary policy • Furthermore, central bank independence is considered one of the fundaments for the modern centralbanking policies 59 • Central bank independence is usually defined as central banks’ autonomy from the government and budget financing pressures • Basically, there are two types of independence – Economic independence – Political independence 60 • ECONOMIC INDEPENDENCE – Limited and/or strictly forbidden credit financing of the state – problems with liquidity or budget deficit must not be solved by printing money – Choice of national monetary policy instruments is especially important in cases of inplementing the unpopular measures and instruments 61 • POLITICAL INDEPENDENCE relates to the choice of governor and board members independent from political influences and pressures from different lobbies (e.g. financial or banking sector) 62 Monetary policy and deficit financing Legal aspect Price stability objective aspect Central bank independence Political aspect Exchange rate policy aspect Acountability and transparency aspect Aspects of central bank independence 63