Chapter 8 Central Banking and the Conduct of Monetary Policy

1. Chapter 8 Central Banking and the Conduct of Monetary Policy

2. Requirement • 1.Grasp • (1)main component of balance sheet of the central bank • (2)the process of multiple deposit creation and simple money multiplier. • (3)money multiplier corresponding to M1

3. (4)Factors affect money multiplier and money supply. • (5)tools of monetary policy and their features. • (6)goals of monetary policy • (7)targets of monetary policy and criteria for choosing targets

4. 2.main points • (1)Factors affect money multiplier and money supply. • (2) tools of monetary policy and their features.

5. Key words • Open market operations • Defensive open market operation • Dynamic open market opration • Excess reserve • Required reserve • Monetary base (high powered money) • Multiple deposit creation • Simple deposit multiplier • Money multiplier • Nonborrowed monetary base

6. Discount window • Lender of last resort • Repurchase agreement • Intermediate targets • Operating target • Philips curve • Taylor rule

7. Ⅰ Balance sheet of central bank

8. 1Assets • 1.1 Government securities. • 1.2 Discount loans. • 2. liability • 2.1 currency in circulation • 2.2 Reserves • Required reserve • Excess reserve

9. 3.monetary base • the monetary base (also called high-powered money) • MB=C+R

10. Ⅱ Multiple Deposit Creation: A Simple Model • 1.multiple deposit creation • When the central bank supplies the banking system with a given amount of additional reserves, deposits increase by a multiple of this amount, this process called multiple deposit creation.

11. 2. hypotheses commercial banks have 2.1 only checking account, and don’t have time deposit and saving deposit account • 2.2 There is no excess reserve somewhere in the banking system. • 2.3 There is no cash outflow in the banking system.

12. 3. Analyze • 3.1 process of Multiple Deposit Creation • Assume that required reserve ratio is 10%, and $1000 of deposits is deposited at Bank A.

14. 3.2 deriving the formula for multiple deposit creation • RR= r×D • D= RR/ r • ⊿D= ⊿RR/ r • Variable m is the simple money multiplier m=⊿D/⊿RR=I/ r

15. Ⅲ determinant of money supply • 1.the Money Supply Model and the Money Multiplier • In deriving a model of the money supply process, money supply corresponds to M1 • r=RR/D • e=ER/D • c=C/D m=(1+c)/( r+e+c)

16. 2.Factors That Determine the Money Multiplier • 2.1 required reserve ratio r • 2.2 currency ratio c • 2.3 excess reserves ratio e • 2.3.1 market interest rate. • 2.3.2 deposit outflows

17. 3.Additional Factors That Determine the Money Supply • nonborrowed monetary base :The monetary base except discount loan

18. MBn=MB﹣DL • where MBn=nonborrowed monetary base • MB=monetary base • DL=discount loans from the Fed • M=m×(MBn+DL)

20. discussion • What is the function of central bank?

21. Ⅳ Tools of Monetary Policy • 1.Open market operation • 2.discouunt loan • 3.reserve requirements

22. 1. open market operation • 1.1 open market operations • The central bank exercises control over the monetary base through its purchases or sale of government securities in the open market. • 1.2 A purchase of bonds by the central bank is called an open market purchase, and a sale of bonds by the central bank is called an open market sale.

23. 1.3 There are two types of open market operations: • 1.3.1 Dynamic open market operations: are intended to change the level of reserves and the monetary base, • 1.3.2 Defensive open market operations: are intended to offset movements in other factors that affect reserves and the monetary base,

24. 1.4 influence on money supply • Open market purchase R+C • Open market sale R+C

25. 1.5 advantage of open market operation • 1.5.1 Open market operations occur at the initiative of the central bank • 1.5.2 Open market operations are flexible and precise • 1.5.3 Open market operations are easily reversed. • 1.5.4 Open market operations can be implemented quickly

26. 1.7 Method of open market purchase and sale • 1.7.1 open market purchase • Repurchase agreement • the central bank purchases securities with an agreement that the seller will repurchase them in a short period of time, anywhere from 1 to 15 days from the original date of purchase. • 1.7.2 open market sale • matched sale–purchase transaction • (sometimes called a reverserepo): the central bank sells securities and the buyer agrees to sell them back to the Fed in the near future.

27. 2. Discount Policy • 2.1 discount window: • The central bank facility at which discount loans are made to banks is called the discount window. • 2.2 mechanism of discount window

28. 2.3 advantages and disadvantage of discount policy • 2.3.1 advantages • lender of last resort

29. 2.3.2 disadvantage of discount policy • (1)announcement effect • (2) adjustment of discount rate may lead to unintended fluctuations in the volume of discount loan and money supply • (3)discount loan can not be controlled completely by the central bank • (4)cannot be easily reversed compared with open market operation

30. 3.reserve requirements • 3.1 mechanism • 3.2 advantages and disadvantages of reserve requirement • 3.2.1 advantages • 3.2.2disadvantages • 3.2.2.1 small changes in the money supply and interest rates are hard to engineer by varying reserve requirements. • 3.2.2.2 raising the requirements can cause immediate liquidity problems for banks with low excess reserves.

31. changes in reserve requirement ratio of U.S.

33. discussion • Why “reserve requirement ” is the most frequently used monetary policy tools in China?

34. Ⅴ conduct of monetary policy : goals and target • 1.Goals of monetary policy • 1.1 high employment • 1.2economic growth • 1.3price stability • 1.4 interest rate stability • 1.5stability in foreign exchange markets • 1.6 stability in financial markets

35. 2. Target of monetary policy • 2.1intermediate target : variables which have a direct effect on goals of monetary policy. • such as the monetary aggregates (M1, M2, or M3) or interest rates (short- or long-term)

36. 2.2 operating targets( alternatively instrument targets) • Variables which are more responsive to its policy tools. • such as reserve aggregates (reserves, non-borrowed reserves, monetary base, or nonborrowed base) or interest rates (interbank offered rate or Treasury bill rate),

37. Tools of monetary policy operating target Intermediate Target Goal of Monetary policy

38. 2.3 Choosing the Targets • Measurability • Controllability • Predictable Effect on Goals

39. Summary • 1.the balance sheet of the central bank composed by the asset and liability. Discount loans and government securities belong to the asset of the central bank and reserves and currency in circulation are the liability of central bank. increase of discount loan will make the reserves of central bank increase and increase of government securities hold by central bank will make the reserves and currency in circulation rise.

40. 2.When the central bank supplies the banking system with a given amount of additional reserves, deposits increase by a multiple of this amount, we call this process as multiple deposit creation. Simple money multiplier m=⊿D/⊿RR=1/ r, money multiplier corresponding to money supply M1,m=(1+c)/(r+e+c), in which r=RR/D,e=ER/D,c=C/D.

41. 3.money supply MS=m×MB, MB is monetary base, MB=reserves+ currency in circulation, factors affect money supply are: required reserve ratio r ,currency ratio c, excess reserves ratio e, market interest rate, deposit outflows, discount loan and nonborrowed monetary base. • 4.Open marker operation, discount loans and reserve requirement are tools of monetary policy. Among them, open market operation is most commonly used tools and the others two can not be used frequently.

42. 5. All central banks consequently pursue a different strategy for conducting monetary policy by aiming at variables that lie between its tools and the achievement of itsgoals. variables which have a direct effect on goals of monetary policy are intermediate target of monetary policy, such as the monetary aggregates (M1, M2, or M3) or interest rates (short- or long-term). Operation targets are variables which are more responsive to monetary policy tools, such as reserve aggregates (reserves, non-borrowed reserves, monetary base, or nonborrowed base) or interest rates (inter bank offered rate or Treasury bill rate)

43. Reference book • 1. Frederic S. Mishkin , “money strategy", Massachusetts institution of technology, 2007 • 2. Akhand Akhtar Hossain, “Central Banking and Monetary Policy in the Asia-pacific”, Edward Elgar publishing limited,2009