Transcript Monetary Policy

Monetary Policy
Econ 102
2015
Money market equilibrium
 Key player in the financial markets:
CENTRAL BANKS:
Every sovereign nation has a bank which is the ‘lender
of the last resort’.
The Central Banks is a financial institution owned by the
government, which is in charge of ‘managing the
currency’
Central Banks
 Turkey:
Türkiye Cumhuriyeti Merkez
Bankası (TCMB)
 United Kingdom:
Bank of England (BoE)
 United States:
(FED)
Federal Reserve System
Board of Governors
 European Union:
European Central Bank (ECB)
Functions of the Central Bank
1.
2.
3.
4.
Issuance of currency: Prints or mints notes and coins for
the gov’t (usually backed by the gov’t bonds).
Reserve management: manages the foreign exchange
reserves, buys and sells to influence the domestic
currency value/
Banker to the government:
Banker to the commercial banks: provides payment
system for the transactions between banks, provides
liquidity to the banks.
Functions of the Central Bank
5. Maintains financial stability: lender of the last
resort, emergency liquidity to solvent financial
institutions, otherwise they may collapse.
6. Banking supervision: (BDDK)
7. Monetary Policy Function: prevent inflation.
Monetary Policy Tools
1.
Open Market Operations: CB buys and sells gov’t
bonds in private financial markets.
2. Reserve Requirement Ratio:
Minimum reserves that the commercial banks
have to hold as reserves for a given
deposits
3. Discount rate: Lending rate of the Central Bank to
commercial banks
Balance Sheet of the Central Bank
 Assets
 Foreign government bonds (official international reserves)
 Gold (official international reserves)
 Domestic government bonds
 Loans to domestic banks (called discount loans in US)
 Liabilities
 Deposits of domestic banks
 Currency in circulation (previously central banks had to give up
gold when citizens brought currency to exchange)
Central Bank
Central Bank (TCMB) Balance Sheet
Money Market Operations and
Control of Money Supply and interest
rates
1. One tool is the open market operations:
CB can sell bonds and create shortages of liquid funds,
this will decrease the price of bonds and increase the
interest rates because the funds are scarce.
2. CB can change in the interest rate (discount rate) that
they charge to the commercial banks that borrow from
the CB in case of liquidity shortages. If the discount rate
changes the market determined interest rates also
change in the same direction.
Money Market Operations and
Control of Money Supply and interest
rates
3. CB Bank can change the reserve requirement
ratios. This determines the amount of loans that
commercial banks can give for a given amount of
deposits, hence the money multiplier. This tool is
seldom used.
Does the CB control MS or the
Interest rate? Or both???
 Money market
i
 Can they use both at the
same time?
MS is the quantity and
interest is “price” of
money.
 Either the MS or the
interest rate
(Either the quantity
or
the price)
Does CB control MS or the interest
rate?
 Which one is easier to control?
- Your can control the narrowest money supply (which
is the liquidity – bank notes and coins)
- It is more difficult to control broad money supply
(liquidity plus demand deposits (M1))
Alternative Central Bank Policies

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Inflation targeting
Monetary targeting
Exchange rate targeting
Discretionary monetary policy.
Simple Monetary Policy
 Transmission mechanism of the monetary policy.
 Example: MS increase (interest rate declines),
 Desired Investment expenditures increase,
 Aggregate expenditures increase, (Aggregate Demand
increase)
 Hence, OUTPUT increases.
 BUT, there will be an effect on PRICE and/or
EXCHANGE RATES
Expectations
 Consumer and Producers do not have static views, they
look into the future and form ‘expectations’.
 They form expectations about future prices, or the rate of
change of prices.
 In all their consumption, production and labor supply
decisions they take the expected inflation rate into
consideration.
 What is your expected rate of inflation today for the next
year in Turkey?
Turkey’s disinflation policy
Policy change
 Fiscal Deficit
 Monetization of fiscal
deficit
 Weak banking system
 Tight fiscal policy
 Central Bank
independence
 Banking reforms
 INFLATION
 DISINFLATION
Central Bank Independence
 Governments make a CB law which says that CB is
independent and has the objective of controlling
inflation and growth.
Inflation targeting
 To achieve price stability they set an inflation target
rate of x percent for the CPI increase in the following
12 months.
 Then makes monthly forecasts of inflation looking
two years ahead. Then decides whether the interest
rates should be changed to avoid a deviation from the
target.
Central Bank
 If credible everybody will adjust their expected
inflation to the one announced by CB.
 If they are not credible, because for example if they
believe that with coming elections that will resort to
expansionary policy, hence they will not be able to
control the inflation rate...
Inflation experience
Disinflation experience
Inflation realized and expected
 CBRT “inflation is
expected to be between
8.2 and 9.4 % (with a midpoint of 8.17 percent) at
the end of 2014.”
Inflation report 2013.
Inflation report of 2014
TCMB Policies
Asymmetric Interest rate Corridor
Asymmetric Interest rate Corridor
Since 2010
Reserve Option Mechanism
 Commercial banks voluntarily hold part of their
reserve requirements in terms of foreign exchange
and gold.
 Weaken the effect of capital flows to exchange rates
and bank lending
Why the CB can not target one level
of inflation rate?
 What are the other factors that affect the rate of inflation
rate other than money supply growth rate?
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Fiscal policy,
Developments affecting business and trade in the country,
Developments affecting households
Developments affecting labor markets, unemployment
Wages and input prices
Foreign exchange and stock prices
Other difficulties of monetary policy
 Lags –delays between the start of the problem, and
the effect of the policy.
Recognize the problem, decide on the action
and implementing, then the effect will be
observed.... Delays
 Others...