central bank’s monetary policy
DESCRIPTION
Program Magister Akuntansi Universitas Trisakti. Central Bank’s Monetary Policy. Scope of discussion. How the monetary sector affects the economy? Macroeconomic policy Demand and supply of money Transmission of monetary policy Monetary policy in the long-run Policy conflicts - PowerPoint PPT PresentationTRANSCRIPT
Scope of discussion
How the monetary sector affects the economy?Macroeconomic policyDemand and supply of moneyTransmission of monetary policyMonetary policy in the long-run Policy conflictsFramework of monetary policy
EXTERNAL SECTOR
Current AccountExportImport
TransferIncome
Capital & Financial Transaction
Direct Investment Financial flows
– Government– Private
Official foreign reserves
REAL SECTOR
Consumption Investment Export Import
GOVERNMENT SECTOR
Fiscal (APBN)Revenues, incl. grantExpenditures Primary balances Financing – Domestic – External Luar Negeri
MONETARY SECTOR
Monetary Authority Foreign assets net Domestic assets net Net Claim on Government
Commercial Banks Foreign assets net Domestic assets net
Base money
Money supply
How the monetary sector affects the economy? (Interrelationship among macroeconomic accounts)
Aggregate demand:Y = C + I + G + (X-M)
Macroeconomic policy
KEBIJAKAN EKONOMI MAKRO:
KEBIJAKAN MONETER
KEBIJAKAN FISKAL
KEBIJAKAN PERDAGANGAN
KEBIJAKAN TENAGA KERJA
KEBIJAKAN LAINNYA
TUJUAN AKHIR:SOCIAL
WELFARE
KEBIJAKAN EKONOMI MAKRO:
KEBIJAKAN MONETER
KEBIJAKAN FISKAL
KEBIJAKAN PERDAGANGAN
KEBIJAKAN TENAGA KERJA
KEBIJAKAN LAINNYA
TUJUAN AKHIR:SOCIAL
WELFARE
Monetary policy is an integral part of macroeconomic policy The ultimate target of macroeconomic policy is economic/social
welfare
Supply and Demand for Money
Supply of money : Ms = mm * Mo determined by the central bank. (Baca AP Lampiran 2.2)
Demand for money : Md = f (GDP, CPI) determined by people or money holder
Definition of money: Mo = C + Rb where Mo = monetary base (high-powered money) ; C = Currency (bank notes);
Rb = Bank reserves (banks’ account at the central bank + cash in vault)
M1 = C + DD where DD = Demand deposits (checking accounts, giro accounts)
M2 = C + DD + TD where TD = Saving and Time deposits
M3 = M2 +
Supply of money: Money multiplier (Baca AP Box 4.2)
Total reserves (Rb) = Required reserves + Excess reserves
Total reserves = Deposits at the Central Bank + Vault cash at commercial banks
Money multiplier (mm) = 1/ (RR +ER) where RR is required reserves ratio (reserve requirements) and ER is the proportion of excess reserves in total reserves
Ms = mm x Mo --- mm = Ms/Mo mm¹ = M1/Mo (narrow money multiplier) mm² = M2/Mo (broad money multiplier)
In practice, the mm can be calculated directly from central bank statistics published by the central bank where Mo, M1 and M2 are regularly (monthly) published. For example, at year-end 2004 the monetary base at BI’s publication is Rp 200 trio and M2 Rp800 trio, then the money multiplier is 800/200 = 4.0.
Reserve requirement
In the most countries, all depository financial institutions are required to conform to the deposit reserve requirements (giro wajib minimum) set by the central bank.
Changes in reserve requirements are a very potent, though little-used tool.
Indeed, reserve requirements have recently been reduced in the U.S., and eliminated in Canada, New Zealand, and the U.K.
An increase in deposit reserve requirements decreases the deposit and money multipliers, slowing the
growth of money, deposits and loans reduces the amount of excess legal reserves - institutions
deficient in required legal reserves will have to sell securities, cut back on loans, or borrow reserves
increases interest rates, particularly in the money market, as depository institutions scramble to cover any reserve deficiencies
Supply and Demand for Money - Equilibrium Supply of money is determined by the central bank monetary policy, and therefore the supply
curve is vertical. Demand for money is inversely related to the money rate of interest, because higher interest rates
make it more costly to hold money instead of interest-earning assets like bonds. Equilibrium: The money interest will gravitate the rate where the quantity of money people want to
hold (demand) is just equal to the stock of money the central bank has supplied (supply).
Quantityof Money
Interest rate Ms
Md
Qs
i*
At i*, people are willing to hold the money supply set by the central bank
Excesssupply
Excessdemand
i2
i3
Transmission of monetary policy The path that monetary policy takes through the macroeconomic system is called the Transmission
of Monetary Policy. The impact of a shift in monetary policy is generally transmitted through intrest rates, exchange
rates, and assets prices. An expansionary monetary policy will increase supply of loanable funds and put downward
pressure on real interes rates. As real interest rates falls, aggregate demand increases (to AD2), leading to a short run increase in output (Y1 to Y2…..and prices (from P1 to P2)… inflation
Goods/services(real GDP)
Price level
AS1
AD1
Y1 Y2
P1AD2
P2
Quantity of Loanable funds
RealInterest rate
Q
r2 D
S1 S2
Direct monetary transmission 11
Money
MonetaryPolicy:
Base moneyInterest rate
Final Objective:
PricesOutput
Interest rate channel
Real interest
Cost of capital
Substitution effect
Income effect
Asset price channel
Exchange rateNet exports-cap.flows
Tobin’s q
Wealth effect
Credit channels
Bank lending Loan Supply-Demand
Ext. Financing, LeverageFirms balance sheet
Imported prices
Equity-Property prices
Expectation channel
Expectation Real interest rate
Moral hazard,Adverse selection
Uncertainty
Money Supply-Demand
The Mechanism of monetary transmission
Monetary policy in the long-run If the impact of an increase in AD accompanying expansionary policy is felt when the economy
operating below capacity, the policy will help direct the economy back to a long-run full employment output equilibrium (Yf).
In contrast, if the demand-stimulus effects are imposed on an economy already at full employment (Yf), they will lead to excess demand, higher prices,and temporarily higher output (Y2).
In the long-run, the strong demand will push up resources prices, shifting back short-run AS. The price level rises to P3 (from P2) and output back to Yf once again.
Goods/services(real GDP)
Price level
SRAS1
AD1
Yf Y2
P1
AD2P2
Goods/services (real GDP)
PriceLevel
Y1
P2
AD1
SRAS1
LRAS
AD2P1
Yf
e1
e2
SRAS2
LRAS
P3
e1
e2
e3
Monetary policy in the long-run
The quantity theory of moneyM * V = P * Y where M = money; V = velocity of money;
P = price; Y = income If V and Y are constant, than an increase in M would lead to a
proportional increase in P.
Implication: In the long run, the primary impact of monetary policy will be on prices
rather than on real outputWhen expansionary monetary policy leads to rising prices, monetary
authorities eventually anticipate the higher inflation and build it into their choices
As it happens, nominal interest rates, wages, and incomes will reflect the expectation of inflation, and so real interest rates, wages, and output will return to their long-run normal levels.
Policy conflicts
Theoretically, in the short-term there is trade-off between achieving targets of containing inflation and promoting outputPhillips Curve: = (y – y*) Long-run full employment vs below capacity
However, there is growing research evidence that maximum employment, sustainable economic growth, and price stability can be compatible with one another in the longer run.
Expantionary monetary policy leads to promote economic activities, but would in turn push inflation upward A need to strike a balance between monetary and fiscal policy and other macroeconomic policies policy coordination.
Framework of monetary policy
UltimateTarget
IntermediateTarget
OperationalTargetInstruments
•Price stability•Economic growth•Employment
Monetary aggregates• M1, M2, M3• Interest rates
•Base money (Mo)•Bank reserves•Interest rates
•Open market operation•Reserve requirement•Discount facility
Not every nation makes it clear to its central bank what its priorities should be among different possible goals (targets).•The goals may also conflict with one another.
•For example, controlling inflation may require the central bank to slow down the domestic economy through restrictions on credit growth and higher market interest rates.
•However, this policy threatens to generate more unemployment and subdue economic growth.
The Goal of Controlling Inflation (& Deflation)
Inflation creates undesirable distortions in the allocation of scarce resources.
In the 1990s, several central banks (such as New Zealand, Canada, and U.K.) began setting target inflation rates or rate ranges.
In 2000s, several Asian central banks (Thailand, Indonesia,etc.) also set inflation targeting.
The U.S. has not set an explicit target, though it seeks to drive inflation so low that it does not affect business and consumer decisions.