Professional Documents
Culture Documents
Monetary
Policy
Meaning and Functions of Money
• Liabilities
– sight deposits
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Financial System in the UK
• The key role of banks
– deposits and loans
– liabilities and assets
– retail and wholesale deposits and loans
• Liabilities
– sight deposits
– time deposits
Balance sheet of UK banks: February 2003
Financial System in the UK
• The key role of banks
– deposits and loans
– liabilities and assets
– retail and wholesale deposits and loans
• Liabilities
– sight deposits
– time deposits
– certificates of deposit
Balance sheet of UK banks: February 2003
Financial System in the UK
• The key role of banks
– deposits and loans
– liabilities and assets
– retail and wholesale deposits and loans
• Liabilities
– sight deposits
– time deposits
– certificates of deposit
– repos
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Financial System in the UK
• Assets
– short-term loans
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Financial System in the UK
• Assets
– short-term loans
– longer-term loans
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Balance sheet of UK banks: February 2003
Financial System in the UK
• Liquidity and profitability
– profitability
– liquidity
• the liquidity ratio
Balance sheet of UK banks: February 2003
Financial System in the UK
• The central bank
– Bank of England, ECB, Fed, etc.
– functions
• note issue
• acts as a bank
– to the government
– to overseas central banks
• overseas activities of banks
• provides liquidity to the banks
– lender of last resort
• operates monetary and exchange rate
policy
Financial System in the UK
• The London money market
– the discount and repo markets
• discounting
• the repo market
• last-resort facilities by Bank of England
– the parallel money markets
• the inter-bank market
• inter-companies deposit market
• market for certificates of deposit, etc.
• foreign currencies market
The Supply of Money
– monetary base
– broad money
• Definitions in the UK
£ million
£ million
£ million
– monetary base
– broad money
• Definitions in the UK
£ million
+ Repos 88 978
+ Money market funds and paper 57 496
= M3 1 069 331
UK monetary supply using ECB measures:
(end February 2003)
£ million
+ Repos 88 978
+ Money market funds and paper 57 496
= M3 1 069 331
UK monetary supply using ECB measures:
(end February 2003)
£ million
+ Repos 88 978
+ Money market funds and paper 57 496
= M3 1 069 331
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
– simple illustration
Credit creation: Banks' original balance sheet
Credit creation: Effect of a new deposit of £10bn
Credit creation: Full effect of a new deposit of £10bn
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
– simple illustration
– the bank multiplier
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
– simple illustration
– the bank multiplier
• 1/L
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
– simple illustration
– the bank multiplier
• 1/L
– the real world
The Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
• The creation of credit
– simple illustration
– the bank multiplier
• 1/L
– the real world
• no precise bank multiplier
The Supply of Money
• Causes of increases in money supply
– banks reduce liquidity ratio
MS
Rate of interest
O
Quantity of money
The supply of money curve: (b) endogenous money supply
MS
Rate of interest
O
Quantity of money
The Demand for Money
• The motives for holding money
– transactions and precautionary motive
– assets or speculative motive
– the total demand for money
• Determinants of demand for money
– money national income
– frequency with which people are paid
– financial innovations
– speculation about future return on assets
– rate of interest
The demand for money (liquidity preference) curve
Rate of interest
Md
O
Money
Monetary Equilibrium
• Equilibrium in the money market
– equilibrium interest rate where D and S
of money are equal
Equilibrium in the money market
MS
Rate of interest
re
Md
O Me
Money
Monetary Equilibrium
• Equilibrium in the money market
– equilibrium interest rate where D and S
of money are equal
• Equilibrium in the foreign exchange
market
Monetary Equilibrium
• Equilibrium in the money market
– equilibrium interest rate where D and S
of money are equal
• Equilibrium in the foreign exchange
market
– increased money supply leads to lower
interest rates
Monetary Equilibrium
• Equilibrium in the money market
– equilibrium interest rate where D and S
of money are equal
• Equilibrium in the foreign exchange
market
– increased money supply leads to lower
interest rates
– lower interest rates lead to a lower
exchange rate
Monetary Equilibrium
• Effects of changes in money supply on
national income
– effect on interest rates
• Ms↑ → r↓
The demand for and supply of money
MS
Rate of interest
r1
Md
O Q1
Money
The demand for and supply of money
MS ' MS
Rate of interest
r2
r1
Md
O Q2 Q1
Money
Monetary Equilibrium
• Effects of changes in money supply on
national income
– effect on interest rates
• Ms↑ → r↓
– effects of changes in interest rates on
investment
• r↓ → I↑
Monetary Equilibrium
• Effects of changes in money supply on
national income
– effect on interest rates
• Ms↑ → r↓
– effects of changes in interest rates on
investment
• r↓ → I↑
– effects of changes in interest rates on the
exchange rate, and imports and exports
• r↓ → er↓→ X↑, M↓
Monetary Equilibrium
• Effects of changes in money supply on
national income
– effect on interest rates
• Ms↑ → r↓
– effects of changes in interest rates on
investment
• r↓ → I↑
– effects of changes in interest rates on the
exchange rate, and imports and exports
• r↓ → er↓→ X↑, M↓
– effects of changes in investment, imports
and exports on national income
• I↑, X↑, M↓ → Y↑
Monetary Policy
• The significance of monetary policy
• The policy setting
– relationship between the government
and the central bank
– degree of central bank independence
– credit rationing
Effectiveness of Monetary Policy
r1
O Q2 Q1
Loans
An inelastic demand for loans
will be necessary
r2
r1
O Q2 Q1
Loans
Effectiveness of Monetary Policy