money and monetary policy. meaning and functions of money the functions of money –medium of...
TRANSCRIPT
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Money and Monetary
Policy
Money and Monetary
Policy
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Meaning and Functions of MoneyMeaning and Functions of Money
• The functions of money
– medium of exchange
– means of storing wealth
– means of evaluation
– means of establishing value of future claims and payments
• What should count as money?
– narrow definitions of money
– broad definitions of money
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Financial System in the UKFinancial System in the UK
• The key role of banks
– deposits and loans
– liabilities and assets
– retail and wholesale deposits and loans
• Liabilities
– sight deposits
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial 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
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial 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
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial 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
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial System in the UK
• Assets
– cash and balances with the Bank of England
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial System in the UK
• Assets
– cash and balances with the Bank of England
– short-term loans
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial System in the UK
• Assets
– cash and balances with the Bank of England
– short-term loans
– longer-term loans
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial System in the UK
• Liquidity and profitability
– profitability
– liquidity
• the liquidity ratio
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Balance sheet of UK banks: February 2003Balance sheet of UK banks: February 2003
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Financial System in the UKFinancial 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
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Financial System in the UKFinancial 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
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The Supply of MoneyThe Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
– definitions in the UK: M0, M4
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UK monetary aggregates: (end February 2003)UK monetary aggregates: (end February 2003)
Cash outside Bank of England
+ Banks’ operational deposits with Bank of England
= M0
Cash outside banks (in circulation)
+ Private-sector retail bank and building society deposits
= Retail deposits and cash in M4 (also known as M2)
+ Private-sector wholesale bank and b.s. deposits + CDs
= M4
36 861
91
36 952
30 630
676 969
707 599
295 996
1 003 595
£ million
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UK monetary aggregates: (end February 2003)UK monetary aggregates: (end February 2003)
Cash outside Bank of England
+ Banks’ operational deposits with Bank of England
= M0
Cash outside banks (in circulation)
+ Private-sector retail bank and building society deposits
= Retail deposits and cash in M4 (also known as M2)
+ Private-sector wholesale bank and b.s. deposits + CDs
= M4
36 861
91
36 952
30 630
676 969
707 599
295 996
1 003 595
£ million
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UK monetary aggregates: (end February 2003)UK monetary aggregates: (end February 2003)
Cash outside Bank of England
+ Banks’ operational deposits with Bank of England
= M0
Cash outside banks (in circulation)
+ Private-sector retail bank and building society deposits
= Retail deposits and cash in M4 (also known as M2)
+ Private-sector wholesale bank and b.s. deposits + CDs
= M4
36 861
91
36 952
30 630
676 969
707 599
295 996
1 003 595
£ million
![Page 36: Money and Monetary Policy. Meaning and Functions of Money The functions of money –medium of exchange –means of storing wealth –means of evaluation –means](https://reader036.vdocuments.site/reader036/viewer/2022062518/56649e235503460f94b11a0c/html5/thumbnails/36.jpg)
The Supply of MoneyThe Supply of Money
• Definitions of the money supply
– monetary base
– broad money
• Definitions in the UK
– definitions in the UK: M0, M4
– euro zone definitions: M1, M2, M3
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UK monetary supply using ECB measures:(end February 2003)
UK monetary supply using ECB measures:(end February 2003)
Currency in circulation
+ Overnight deposits
= M1
+ Deposits with agreed maturity up to 2 years
+ Deposits redeemable up to 3 months' notice
= M2
+ Repos
+ Money market funds and paper
= M3
31 351
513 292
544 643
81 696
296 518
922 857
88 978
57 496
1 069 331
£ million
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UK monetary supply using ECB measures:(end February 2003)
UK monetary supply using ECB measures:(end February 2003)
Currency in circulation
+ Overnight deposits
= M1
+ Deposits with agreed maturity up to 2 years
+ Deposits redeemable up to 3 months' notice
= M2
+ Repos
+ Money market funds and paper
= M3
31 351
513 292
544 643
81 696
296 518
922 857
88 978
57 496
1 069 331
£ million
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UK monetary supply using ECB measures:(end February 2003)
UK monetary supply using ECB measures:(end February 2003)
Currency in circulation
+ Overnight deposits
= M1
+ Deposits with agreed maturity up to 2 years
+ Deposits redeemable up to 3 months' notice
= M2
+ Repos
+ Money market funds and paper
= M3
31 351
513 292
544 643
81 696
296 518
922 857
88 978
57 496
1 069 331
£ million
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The Supply of MoneyThe Supply of Money
• Definitions of the money supply– monetary base
– broad money
• Definitions in the UK
• The creation of credit
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The Supply of MoneyThe Supply of Money
• Definitions of the money supply– monetary base
– broad money
• Definitions in the UK
• The creation of credit– simple illustration
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Credit creation: Banks' original balance sheetCredit creation: Banks' original balance sheet
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Credit creation: Effect of a new deposit of £10bn Credit creation: Effect of a new deposit of £10bn
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Credit creation: Full effect of a new deposit of £10bn Credit creation: Full effect of a new deposit of £10bn
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The Supply of MoneyThe 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
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The Supply of MoneyThe 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
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The Supply of MoneyThe 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
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The Supply of MoneyThe 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
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The Supply of MoneyThe Supply of Money
• Causes of increases in money supply
– banks reduce liquidity ratio
– inflow of funds from abroad
– PSNCR and its financing
• Money supply: exogenous or endogenous?
– Relationship between money supply and the rate of interest
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The supply of money curve: (a) exogenous money supplyThe supply of money curve: (a) exogenous money supply
O
Ra
te o
f in
tere
st
Quantity of money
MS
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The supply of money curve: (b) endogenous money supplyThe supply of money curve: (b) endogenous money supply
O
Ra
te o
f in
tere
st
Quantity of money
MS
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The Demand for MoneyThe 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
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The demand for money (liquidity preference) curveThe demand for money (liquidity preference) curve
O
Ra
te o
f in
tere
st
Md
Money
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Monetary EquilibriumMonetary Equilibrium
• Equilibrium in the money market– equilibrium interest rate where D and S
of money are equal
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Equilibrium in the money marketEquilibrium in the money market
O
Ra
te o
f in
tere
st
Md
Money
MS
re
Me
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Monetary EquilibriumMonetary Equilibrium
• Equilibrium in the money market
– equilibrium interest rate where D and S of money are equal
• Equilibrium in the foreign exchange market
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Monetary EquilibriumMonetary 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
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Monetary EquilibriumMonetary 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
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Monetary EquilibriumMonetary Equilibrium
• Effects of changes in money supply on national income– effect on interest rates
• Ms r
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The demand for and supply of moneyThe demand for and supply of money
O
Money
Ra
te o
f in
tere
st
MS
Md
r1
Q1
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O
Money
Ra
te o
f in
tere
st
Md
r1
Q1
r2
Q2
MS' MS
The demand for and supply of moneyThe demand for and supply of money
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Monetary EquilibriumMonetary 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
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Monetary EquilibriumMonetary 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
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Monetary EquilibriumMonetary 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
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Monetary PolicyMonetary Policy
• The significance of monetary policy
• The policy setting
– relationship between the government and the central bank
– degree of central bank independence
• Medium- and long-term policy
– control of banks’ liquidity ratio
– restricting size of PSNCR
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Monetary PolicyMonetary Policy
• Short-term monetary control– techniques to control money supply
• open-market operations
• reduced central bank lending to the banks
• funding
• variable minimum reserve ratios
– techniques to control interest rates• announcing changes in interest rates
• backing up announcements– operations in the discount and repo markets
– credit rationing
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Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
• Medium and long-term control over the money supply: reducing PSNCR– automatic fiscal stabilisers– the desire to cut taxes– difficulty in cutting government
expenditure
• Short-term control of the money supply– use of money supply targets– ways in which banks resist attempts to
restrict the growth in the money supply– demand-determined money supply
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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O
Demand for loans
Q1Q2
Assume that the authoritieswant to reduce the
demand for money to Q2
r1
Loans
Rat
e of
inte
rest
An inelastic demand for loansAn inelastic demand for loans
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r2
O
Demand for loans
r1
Q1Q2
A large rise in therate of interest (to r2)
will be necessary
Loans
Rat
e of
inte
rest
An inelastic demand for loansAn inelastic demand for loans
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money• problem of changing expectations
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money• problem of changing expectations• speculation
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money• problem of changing expectations• speculation
– possible conflict between domestic goals and exchange-rate goals
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money• problem of changing expectations• speculation
– possible conflict between domestic goals and exchange-rate goals
• Using monetary policy
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy
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• Effectiveness of controlling interest rates– inelastic demand for loans
• problem of possibly high interest rates• reasons for an inelastic demand for loans
– unstable demand for money• problem of changing expectations• speculation
– possible conflict between domestic goals and exchange-rate goals
• Using monetary policy– use of interest rates to meet inflation
target
Effectiveness of Monetary PolicyEffectiveness of Monetary Policy