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Central Banking and Monetary Policy PDF

The document discusses the role and objectives of central banks and monetary policy. It explains how central banks implement monetary policy through tools like open market operations, reserve requirements, and interest rates to influence money supply and achieve targets of price stability, economic growth and employment. Some limitations of monetary policy include lagged effects, commercial bank lending behavior, and inflation expectations. The relationship between monetary and fiscal policy is also examined.

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Windyee Tan
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414 views43 pages

Central Banking and Monetary Policy PDF

The document discusses the role and objectives of central banks and monetary policy. It explains how central banks implement monetary policy through tools like open market operations, reserve requirements, and interest rates to influence money supply and achieve targets of price stability, economic growth and employment. Some limitations of monetary policy include lagged effects, commercial bank lending behavior, and inflation expectations. The relationship between monetary and fiscal policy is also examined.

Uploaded by

Windyee Tan
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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GD20503

Financial Markets and Institutions

1
ž The Role of a Central Bank
ž Implementing the Proper Monetary Policy
ž Limitations of Monetary Policy

2
Source: The Edge 3
Monetary Price
Stability Stability

Monetary
Policy
Objectives

Growth
Stability & Currency
High Stability
Employment

4
Source: Bank Negara Malaysia, November 13, 2016

5
Source: Bank Negara Malaysia, December 2, 2016

6
Source: Bank Negara Malaysia, August 9, 2017

7
regulates the
issues the
money
currency
supply

Central
Bank

controls the
lender of last interest
resort
rates

8
9
1. Open Market Operations
a.  Purchase of short-term government
securities money supply
b.  Sale of short-term government securities
money supply

10
2. Adjusting the Reserve Requirement Ratio
a.  The minimum amount of funds that a
commercial bank and depository institutions
must hold.
b.  Reserve requirement adjustments affect
money growth because higher reserves lead
to less borrowing and lower reserves lead to
more borrowing

11
12
3. Adjusting the CB’s Loan Rate (discount rate)
a.  Interest rate set by a central bank for
lending to commercial banks and depository
institutions to meet temporary shortage of
funds.
b.  An increase in discount loans will increase
the money supply and vice versa.

13
14
ž  The monetary policy goals of most central banks
are to achieve a low level of inflation, a low level
of unemployment and economic growth.
ž  They assess indicators of the above mentioned
economic variables before they determine their
monetary policy.

15
16
ž  Monetary policy implemented by the CB is
somewhat dependent on various international
factors:

1.  Impact of domestic currency


a.  A weak currency encourages exports → stimulate
economy.
b.  A strong currency reduces inflationary pressure.
c.  Thus, if economic conditions are weak, a strong
domestic currency will not provide the stimulus
needed to improve conditions.
d.  CB may need to implement a stimulative monetary
policy.

17
2. Impact of global economic conditions
a.  As economic conditions are strongly integrated
across countries, CB usually considers prevailing
global economic conditions when conducting
monetary policy.

18
2. Impact of global economic conditions

Source: Bank Negara Malaysia


19
3. Transmission of Interest Rates
a.  Global interest rates will vary between countries
b.  Countries with higher interest rates will attract investors
from countries with lower interest rates
c.  If investors leave due to falling domestic interest rates,
the CB may believe it should act to prevent rates from
falling lower

20
Transmission of Interest Rates

21
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ž  How Monetary Policy Corrects the Economy:
1.  Correcting a Weak Economy:
a.  CB can increase the level of spending to
stimulate the economy
b.  Use open market operations to increase the
money supply

23
24
Source: Financial Times, August 2, 2016
25
ž  How Monetary Policy Corrects the Economy:
2. Correcting High Inflation
a.  CB can institute a tight-money policy using
open market operations to reduce money
supply growth.

26
27
2. Correcting High Inflation

Source: Reuters, April 12, 2017 28


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1. Limited
Credit Provided by Banks: even if
CB increases the level of bank funds,
banks may be unwilling to extend credit.
ž  Example: 2008/09 Credit Crisis Period
Ø  Commercial banks – raised the standard
necessary to qualify for loans

30
2. Lagged Effects of Monetary Policy:
Ø  a monetary policy may have an immediate
impact on the economy to some degree, but its
full impact may not occur until year or so
after the implementation.

For Example:
Impact lag – the lag from the time the policy is
implemented until the policy has its full impact
on the economy

31
3.  Low Return on Savings:
a. This might lead to personal bankruptcies
Ø  Discourage saving
Ø  Encourage borrowing

b. This might restrict spending


Ø  Retirees that rely on interest income

33
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4.  Impact of a Stimulative Policy on Expected
Inflation:
Ø  Effect of increase in money supply growth may
be disrupted due to an increase in inflationary
expectations.
Ø  Theory of Rational Expectations:
Business and households expect that an
increase in money supply will cause higher
inflation

35
No effect on
economic
growth

37
Source: Bloomberg
38
Assume there is no
inflationary
expectations

39
ž  Inverse relationship between
inflation and unemployment.
a.  Strong economic condition: high
inflation, low unemployment
b.  Weak economic condition: low
inflation, high unemployment
¡  The CB may not be able to
solve both problems
simultaneously. Thus, the CB
must determine whether
unemployment or inflation is
the more serious problem.

40
Exhibit 5.9:
How Monetary Policy
Responds to Fiscal
Policy

CB will conduct
This could dampen
stimulative MP to
theinterest
reduce economy rate

41
ž  The role of a central bank
ž  How central bank controls money supply
ž  Factor affecting monetary policy decision
ž  How monetary policy correct the economy
ž  Limitations of monetary policy

42
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