Embedded Files
Syllabus Content
- Interest rates - Interest rate determination and the role of a central bank
- The role of monetary policy - Monetary policy and short-term demand management, monetary policy and inflation-targeting and evaluation of monetary policy
Task 1: Watch the video on the purpose of the central bank and answer the questions that follow:
- What is 'the minimum deposit programme'?
- What are the two ways in which the central bank of a nation controls monetary policy?
- What is the 'key lending rate'?
- If the central bank wants to reduce the money supply in the economy what will it do to the key lending rate and reserve requirement?
- Identify the four main functions of a central bank
Bank rate examples
The policy rate is the mid-point between the lending facility and the borrowing facility.
Question: find out the difference between the lending facility and the borrowing facility
The central bank's main impact on interest rates is in the overnight rate and approaching 1 month i.e. very short-term money
The higher the term of the loan, the higher the relative interest rate
Interest rates moving in tandem with each other - case of Japan
Change in the required reserve ratio of the People's Bank of China (PBOC)
Reserve Requirement ratios - see http://www.centralbanknews.info/p/reserve-ratios.html
Question: what did the People's Bank of China do in relation to its RRR, and what are the reasons why for this action?
Instruments of monetary policy - movement in tandem (RRR and SHIBOR) in China (2009-2011)
Instruments of monetary policy - movement in tandem (RRR and SHIBOR) in China (2011-2013)
Task 2: Plot the yield curve with time on the horizontal axis and yield/interest rate on the vertical axis.
Can you think of any reasons for why it is shaped the way it is, and what could be the implication for the US economy?
What is Money?
Introduction to monetary policy
Explain, using a demand and supply of money diagram, how equilibrium interest rates are determined, outlining the role of the central bank in influencing the supply of money.
Monetary policy is the use of interest rates and money supply changes to manage the overall level of demand in the economy and, therefore, help achieve the economic objectives set out in previous sections. For examinations you will need to show how monetary policy is used to achieve macroeconomic objectives. So, think about how monetary policy is used to:
• Control inflation
• Help produce growth
• Keep employment as high as possible
• Maintain a satisfactory balance of payments
Keynes’ Theory of Liquidity Preference
• Keynes developed the theory of liquidity preference in order to explain what factors determine the economy’s interest rate.
• According to the theory, the interest rate adjusts to balance the supply and demand for money.
Money Supply
It’s the name economists give to all the money circulating in a given nation’s economy. The US money supply comprises currency (the dollar bills and coins issued by the Treasury and the Federal Reserve System of federal and state banks) and various kinds of deposits held by the public at banks and similar institutions. However, there are several different definitions of the money supply, known as M1, M2 and M3. The broadest measure is M3.
These measures correspond to three definitions of money that the Federal Reserve uses:
• M1, a narrow measure of money’s function as a medium of exchange[1]; It comprises all the paper cash and coins in circulation, plus the total amount in current accounts and instant access savings accounts.
• M2, a broader measure that also reflects money’s function as a store of value[2]; It is made up of M1 plus various other types of savings account, money market accounts[3] and certificate of deposit accounts worth less than $100,000.
• M3, a still broader measure that covers items that many regard as close substitutes for money; M2, plus other items that many regard as close substitutes for money – certificates of deposit worth more than $100,000, deposits of Eurodollars[4] and repurchase agreements[5].
[1] A medium of exchange is an item that buyers give to sellers when they want to purchase goods and services
[2] A store of value is an item that people can use to transfer purchasing power from the present to the future.
[3] The money market is a financial market in which only short-term debt instruments (usually 12 months maturity or less) are traded i.e. 3, 6 and 12-month Government bonds.
[4] US Dollars deposited in foreign banks outside the United States or in foreign branches of US banks are called EuroDollars.
[5] Repurchase agreements (repos) are effectively short-term loans (usually with a maturity of less than two weeks) in which government bonds serve as collateral, an asset that the lender (usually a large corporation) receives if the borrower (commercial banks) does not pay back the loan
How does the money supply affect the economy?
How does the money supply affect the economy?
When the supply of money grows, consumers feel wealthier and are encouraged to spend more on goods and services. Businesses respond to rising sales by buying more raw materials and increasing production – in turn requiring more labour and more capital. However, if the money supply expands too much, prices will start to rise, especially if the growth in output is hitting the limits of capacity. As inflation accelerates, lenders demand higher interest rates on money they lend out to compensate them for the fact that, when they get their money back, it won’t be worth as much as it was when they first lent it out. Conversely, when the supply of money falls, or when its rate of growth falls, the economy can be affected in opposite ways. Economic activity declines and the result is lower inflation (disinflation).
The money supply is controlled by the central bank through:
• Open-market operations i.e. buying and selling of government bonds
• Changing the reserve requirements i.e. the amount of funds deposit-taking institutions must hold as reserves – not allowed to lend out and housed in the institution’s vault.
• Changing the discount rate i.e. rate that the central bank charges commercial banks for funds borrowed. The central bank also sets the base rate that commercial banks lend to each other.
Because it is fixed by the Fed the quantity of money supplied does not depend on the interest rate. The fixed money supply is represented by a vertical supply curve.
Money Demand
Money demand is determined by several factors.
• According to the theory of liquidity preference, one of the most important factors is the interest rate.
• People choose to hold money instead of other assets that offer higher rates of return because money can be used to buy goods and services.
• The opportunity cost of holding money is the interest that could be earned on interest-earning assets.
• An increase in the interest rate raises the opportunity cost of holding money.
• As a result, the quantity of money demanded is reduced.
Equilibrium in the Money Market
According to the theory of liquidity preference:
· The interest rate adjusts to balance the supply and demand for money.
· There is one interest rate, called the equilibrium interest rate, at which the quantity of money demanded equals the quantity of money supplied.
Influence of the global financial crisis on the Singapore Interbank Offered rate (SIBOR)
Question: comment on the trend in SIBOR over the period 2017 to 2018
Explain how changes in interest rates can influence the level of aggregate demand in an economy.
Monetary policy is conducted by the central bank of the country. Monetary policy refers to the attempts to manipulate either the market rate of interest or the money supply so as to bring about desired changes in the economy.
1. Open-Market Operations[1] Welker Wikinomics
Open Market Operations: The first tool of monetary policy requires a central bank to increase or decrease the supply of liquid money in the economy by buying or selling non-liquid assets from from within the banking system. “Open-market operations” refers to the buying and selling of government bonds by a nation’s central bank to increase or decrease the supply of money.
v To increase the money supply, the Fed buys government bonds from the public.
v To decrease the money supply, the Fed sells government bonds to the public.
There is an inverse relationship between the price of government bonds and their yields (the interest rates on government bonds).
· Therefore, when a central bank intervenes in the market for government bonds by buying bonds, this decreases their supply and raises the price, decreasing the yields on government bonds. This is knowns as a expansionary monetary policy.
· If the central bank sells government bonds on the open market, their supply increases, decreasing their prices and increasing their yields. This is known as a contractionary monetary policy.
The effect of a central bank’s intervention in the bond market can be seen in the diagrams below:
1. Reserve Requirements
• The central bank also influences the money supply with reserve requirements.
• Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits.
• Changing the Reserve Requirement
• The reserve requirement is the amount (%) of a bank’s total reserves that may not be loaned out.
• Increasing the reserve requirement decreases the money supply.
• Decreasing the reserve requirement increases the money supply.
2. Changing the Discount Rate
• The discount rate is the interest rate the central bank charges commercial banks for loans.
• Increasing the discount rate decreases the money supply.
• Decreasing the discount rate increases the money supply
Changes in the Money Supply
• The central bank can shift the aggregate demand curve when it changes monetary policy.
• An increase in the money supply shifts the money supply curve to the right.
• Without a change in the money demand curve, the interest rate falls.
• Falling interest rates increase the quantity of goods and services demanded.
• When the Fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded at any given price level, shifting aggregate-demand to the right.
• When the Fed contracts the money supply, it raises the interest rate and reduces the quantity of goods and services demanded at any given price level, shifting aggregate-demand to the left.
Money Demand
There are many factors that determine the quantity of money people demand. How much money people choose to hold in their wallets can depend on how much they rely on credit/debit cards and on whether an automatic teller machine is easy to find. In addition, the quantity of money demanded depends on the interest rate that a person could earn by using the money to buy an interest-bearing bond rather than leaving it in a wallet or low-interest current account.
However, the most important variable to affect money demand is the price level (changes in)
• Individuals demand money to pay for goods and services. How much money they choose to hold for this purpose depends on the prices of those goods and services. The higher the prices the more money the typical transaction requires and the more money people will choose to hold in their wallets and current accounts.
• A higher price level increases the quantity of money demanded for any given interest rate.
• Higher money demand leads to a higher interest rate.
• The quantity of goods and services demanded falls.
The interest rate on government debt and the central bank's policy rate will move in tandem and converge closely
The Tools of Monetary Policy
Monetary Policy and the Fed (US Central Bank)
Task 3: Questions on monetary policy
I. Why can’t a central bank control both the money supply and equilibrium rate of interest simultaneously?
II. Suppose that the reserve requirement for short-term deposits is 10% and that banks do not hold excess reserves.
(a) If the central bank sells €1 million of government bonds, what is the effect on the economy’s reserves and the money supply?
(b) Now suppose that the central bank lowers the reserve requirement to 5%, but banks choose to hold another 5% of deposits as excess reserves. Why might banks do so? What is the overall change in the money supply as a result of these actions?
III. Suppose that changes in bank regulations expand the availability of credit cards, so that people need to hold less cash.
(a) How does this event affect the demand for money?
(b) If the central bank does not respond to this event, what will happen to the price level?
(c) If the central bank wants to keep the price level stable, what should it do?
IV. Under the following conditions, would you decide to increase or decrease your demand for money? Also identify whether the condition affects your transactions demand, precautionary demand or speculative demand.
(a) Your salary doubles
(b) The rate of interest on bonds and other assets fall
(c) An automatic teller machine (ATM) is installed next door, and you have a card.
(d) Bond prices are expected to rise
(e) You are paid each week, instead of monthly
V. Suppose a bond pays annual interest of US$80. Compute the interest rate per year that a bondholder can earn if the bond has a face value of US$800, US$1000 and US$2000. State the conclusion drawn from your calculations.
Monetary policy and short term demand management
Explain how changes in interest rates can influence the level of aggregate demand in an economy. Remember AD is made up of C+I+G+X-M.
Describe the mechanism through which easy (expansionary) monetary policy can help an economy close a deflationary (recessionary) gap.
Expansionary monetary policy
Governments may choose to use expansionary (loose or easy) monetary policy in times of recession or a general downturn in economic activity. This was in widespread use by many governments following the financial crisis on 2008.
In this situation, governments use monetary policy to stimulate the economy. They may do this by lowering interest rates or by increasing the money supply. Following the 2008 credit crunch, periods of Quantitative Easing (Q.E.) took place where governments increased the money supply by purchasing assets of longer maturity than only short-term government bonds with the objective of lowering longer-term interest rates.
Lowering interest rates encourage firms (I) and individuals (C) to borrow and spend more. Increasing the money supply into the national income will similarly increase spending. Either way, the level of demand in the economy (Shifting AD to the right) should rise and help encourage economic growth.
Reflationary monetary policies include:
• Lowering interest rates
• Increasing money supply
These policies should boost aggregate demand and, therefore, the equilibrium level of income.
The increase in aggregate demand occurs for several reasons, including:
1. Falling savings
2. More new borrowing
3. Lower costs of servicing existing debts
4. Rising confidence
5. Greater export demand
6. Rising asset values
7. Rising business investment
For Keynesians, any increase in AD on the horizontal section of the AS curve will not be inflationary. Prices will only increase when full employment is reached and the AS curve becomes vertical. Contrast this with the neoclassical view using a vertical LRAS where in the long run expanding AD does not increase Real Output or lower unemployment.
However, this policy may cause demand-pull inflation. We can see from Figure 4, that the new equilibrium would involve a higher price level. Keynesians argue that reflationary monetary policy sometimes referred to as a loosening or easing of monetary policy, is appropriate where there is spare capacity, as they believe that the economy can settle at any equilibrium level of output.
Interest rates are set so that the inflation target can be met in the future. In fact, it takes up to two years for a rate change to affect inflation, so the Bank of England must try to predict the state of the economy two years in advance!
Interest rates transmit their way to aggregate demand in the following ways:
· Changes in the official rate affect all markets rates, such as overdraft, mortgage, and credit card rates. Consumer demand is affected in a number of ways including affecting savings, which indirectly affect spending, and spending itself. For households or firms with existing debt, such as a mortgage, a change in rates affect repayments, and hence individuals have more (or less) cash after servicing their debts. Changes in rates affect the cash-flow firms and households.
· In the case of new debt to fund spending, borrowing is also encouraged, or discouraged, following interest rate changes. Interest rates also affect consumer and business confidence, and spending.
· Asset prices are also affected by interest rates. For example, a fall in rates will tend to make firms more profitable and they may pay higher dividends to shareholders, which can trigger an increase in spending. Similarly, a rate fall makes property more attractive, increasing the value of property and household wealth.
· Changes in the official rate also affect general expectations and confidence, which alters consumer and corporate behaviour. For example, a rise in rates indicates a tighter monetary stance and has a negative impact on consumer and corporate sentiment, leading to the postponement of discretionary spending.
· Finally, interest rates may affect the exchange rate, which can also influence export demand. For example, a rise in interest rates may raise the exchange rate, pushing up export prices and reducing overseas demand. Changes in the exchange rate also affect the price of imports, which also affect theinflation rate, through its effect on imported costs. For example, a fall in the exchange rate increases import prices and creates cost-push inflation. In this case, a rise in interest rates will push up the exchange rate and ease any cost-push inflationary pressures.
Source - http://www.economicsonline.co.uk/Global_economics/Monetary_policy.html
The way changes in interest rates feed through to increasing or decreasing equilibrium Real GDP is called the Transmission mechanism:
Describe the mechanism through which tight (contractionary) monetary policy can help an economy close an inflationary gap.
Contractionary monetary policy
Contractionary (tight) monetary policy is likely to be most appropriate in times of economic boom.
If the economy is operating at full capacity, further increases in aggregate demand will result in inflation and potential balance of payments problems. In an attempt to slow economic growth and control inflation, the government could increase interest rates and/or reduce the money supply. Either, or both of these policies, will reduce the level of demand in the economy and the level of economic growth.
You need to refer to arguments above but reverse the reasoning including the diagrams (ie AD2 to AD1)
Contractionary (tight) monetary policies include:
• Increasing interest rates
• Reducing the money supply
The effect of these policies will be to shift the aggregate demand curve to the left
Both Neoclassicals and Keynesians maintain that raising interest rates or reducing the supply of money will lower aggregate demand and close an inflationary gap. Keynesians would argue that such actions may overshoot and cause a deflationary situation, with rising unemployment. They have traditionally argued that reducing the money supply may not always be effective. Indeed, any attempt to control the money supply may only speed up the velocity of circulation, to fund spending. In other words, the existing stock of money will simply be used more frequently and changes hands at a quickening rate.
The impact of changes in interest rate on Aggregate Demand
As we saw from the diagram on the transmission mechanism, interest rate changes will affect aggregate demand. For example, if interest rates rise, the impact on aggregate demand will be:
• Consumption - if interest rates are increased then consumers will find that their disposable income is lower (because debt repayments and mortgage repayments will be higher) and they will be less likely to borrow as it is more expensive. This will reduce their consumption. Higher interest rates also make saving more attractive than consuming.
• Investment - higher interest rates will make investment less attractive, as the cost of borrowing and the returns are relatively lower.
• Government expenditure - government also often borrow large amounts of money and if interest rates rise then they will face higher 'debt servicing' costs (higher interest payments).
• Exports and imports - an increase in interest rates may lead to a rise in the exchange rate and this will make exports less price competitive. Exports may fall and imports may rise. However, an increase in interest rates may reduce the overall level of demand and thus the demand for imports in particular.
The aim of monetary policy is generally to manage the economy without causing sudden increases in either inflation or unemployment. Price stability is now central to macroeconomic policy, although following the financial crisis in 2008, and the resultant recession, some governments appear to be prepared to allow inflationary pressures to build (following cost push pressures from increase in commodity prices) and adopt expansionary fiscal and monetary policies in an attempt to avoid a recurring recessions and depressions. Many governments borrowed large amounts to finance expansionary policies in response to the credit crunch and are now having to make large cuts in their government spending in order to pay back the debts incurred.
A successful monetary policy allows for price stability and maximum employment. It should also allow supply-side policies to work. This will be covered in the next section 2.6.
Using monetary policy to close output gaps
US Federal Reserve tightening monetary policy and what impacts this has for the global economy
Task 4: Questions on monetary policy and real economy
I. Using a money market diagram, show why interest rates are pro-cyclical (rising when the economy is expanding and falling during recessions)
II. Explain what effect a large government budget deficit might have on interest rates. Illustrate your answer with an appropriate diagram.
III. Suppose you are the chair of the Monetary Policy Committee and the position of the economy is below full employment level of output. State the likely direction of change in the price level, real GDP, and employment caused by each of the following monetary policies:
(a) The central bank makes an open market sale of government bonds
(b) The central bank reduces the required reserve ratio
(c) The central bank increases the discount rate
Question: has monetary policy become more tight or accommodative in South Korea?
Question: is there a relationship between the policy rate interest rate and the stock market value?
Question: what might have changed the Federal Reserve's opinion on interest rates? According to the information provided (https://www.bankrate.com/rates/interest-rates/federal-funds-rate.aspx) which forecast is closer to the actual Federal Funds rate?
Market anticipation of change in monetary policy - the market anticipated a rise in the overnight rate before it happened (evidence of rational expectations)
Question: why are the BIBOR 1 month and BIBOR 2 months rate closer to the policy interest rate in 2010 but further apart beginning in 2011?
Question: Despite the Federal Reserve in the United States cutting the Federal Funds interest rate (two time periods), the S&P 500 continued to fall. Is this unusual? What could explain this particular relationship?
Monetary policy and inflation targeting
Monetary policy and inflation targeting
Explain that central banks of certain countries, rather than focusing on the maintenance of both full employment and a low rate of inflation, are guided in their monetary policy by the objective to achieve an explicit or implicit inflation rate target.
Most countries choose to aim for a target range for the inflation rate and use monetary policy only when that range is likely to be exceeded. In USA the Fed nowadays is also concerned with low unemployment so quantitative easing is used when unemployment becomes an issue. In Brazil the target Inflation Rate is 2.5% to 6.5%.
So the target is well-exceeded at the moment of writing (Jan 2016)
Flexible inflation targeting
Norges Bank operates a flexible inflation-targeting regime, so that smoothing fluctuations, both in inflation and in output and employment, is given weight in interest rate setting. Flexible inflation targeting builds a bridge between the long-term objective of monetary policy, which is to keep inflation low and anchor inflation expectations, and the objective of smoothing developments in output. Expectations regarding future interest rates play an important role for developments in output, employment, incomes and inflation. Through its interest rate forecasts, Norges Bank influences the interest rate expectations of market participants, enterprises and households.
Interest rate forecasts should satisfy the following main criteria:
• The interest rate should be set with a view to stabilizing inflation at target or bringing it back to target after a deviation has occurred. The relevant time horizon will depend on the type of disturbances to which the economy is exposed and their effect on the path for inflation and the real economy ahead.
• The interest rate path should, at the same time, provide a reasonable balance between the path for inflation and the path for overall capacity utilization in the economy.
• In the assessment, potential effects of asset prices, such as property prices, equity prices, and the krone exchange rate on stability in output, employment and inflation are also taken into account.
Assuming the criteria above have been satisfied, the following additional criteria are useful:
3 Interest rate adjustments should normally be gradual and consistent with the Bank's previous response pattern.
4 Interest rate developments should result in acceptable developments in inflation and output also under alternative assumptions concerning the economic situation and the functioning of the economy. Any substantial and systematic deviations from simple, robust monetary policy rules should be explained.
The interest rate forecast is an expression of Norges Bank's overall judgment and assessment based on the criteria above. Usually, the criteria cannot all be satisfied simultaneously, and the various considerations must therefore be weighed against each other. Forecasts of the key policy rate and other economic variables are based on incomplete information concerning the economic situation and the functioning of the economy. Should developments in the economy differ from assumptions or should the central bank change its view of the functioning of the economy, developments in the interest rate and other variables may deviate from the forecasts.
Question: Price stability is the key objective of Asian central banks. Is this the same for Hong Kong?
Emergence of inflation targeting in central banking 1990 onwards
Emergence of inflation targeting in central banking 1990 onwards
Example of Asian countries using inflation targeting
Question: What does this movement in the upper and lower bounds imply about inflationary expectations in the Philippines?
Inflation targeting in the Philippines
Movement in the upper and lower bounds
Relationship between monetary policy instruments and the inflation target
Consumer Price Index in the Philippines
Consumer Price Index in the Philippines
Question: What action would the Philippines Central Bank have adopted to propel the inflation rate towards the inflation target?
Inflation targets
Inflation targets
Question: is there any particular relationship between the inflation target and the actual central bank?
- How successful have the Fed and ECB been in attaining their implicit inflation targets?
- Canada: a successful inflation targeting story?
- Is inflation targeting (explicit) by some central banks more success than non-inflation targeting central banks?
- See http://www.frbsf.org/education/publications/doctor-econ/2007/march/inflation-targeting-monetary-policy-costs-benefits/
- Limitation of inflation targeting from an institutional perspective
Question on inflation targeting
Question on inflation targeting
Evaluate the effectiveness of monetary policy through consideration of factors including the independence of the central bank, the ability to adjust interest rates incrementally, the ability to implement changes in interest rates relatively quickly, time lags, limited effectiveness in increasing aggregate demand if the economy is in deep recession and conflict among government economic objectives.
The advantages of interest rate policy
Powerful and direct
Evidence shows that interest rates have a direct and powerful effect on household spending, the evidence suggesting that UK consumers are interest rate elastic.
Independent
The Bank of England’s Monetary Policy Committee is independent of government and can make decisions free from political interference.
Easy to implement
Interest rates can be changed on a monthly basis, which contrasts with changes in discretionary fiscal policy, which cannot be made at such regular intervals.
Quick effect on confidence
While the full effects of interest changes may not be experienced for up to two years, there is often an immediate effect on confidence. The time lag affecting output is estimated to be around one year, and on the price level, around two years.
The disadvantages of interest rate policy
There are still time lags to see the full effects, and there are some other negative effects, including:
Investment can suffer
Investment spending is inversely related to interest rates, and higher rates increase the opportunity cost of investment. Long term, economic growth will suffer if high interest rates persist.
The housing market can suffer
The housing market is very sensitive to changes in interest rates, so individual changes tend to be small, partly so as not to have an excessive effect on housing.
The dual economy
There is also the problem of the dual economy. Should rates be set high to control the inflating service sector, or low rates for the depressed manufacturing and export sector? Unlike previous recessions, in the current recession all sectors of the economy have been suffering in a similar way, so rates have been set at historically low levels without any fear of inflation.
The liquidity trap
Reducing interest rates in a recession may be ineffective because of the so-called liquidity trap. This theory is associated with Keynes, and his analysis of the Great Depression. In a recession interest rates will fall towards zero, as in the UK during 2009, following the financial crisis. In this case, banks and other financial intermediaries prefer to hold cash rather than make loans. Therefore, while borrowing may be stimulated, liquidity is not released through the system - it is 'trapped' and unavailable.
This acts to deepen a recession and weaken the real economy. In this case, authorities may have to by-pass the banks and pump money directly into the public's hands. Allocating spending vouchers is one way this could be achieved. This is often referred to a 'helicopter' or 'parachute' money. More formally, the process is called quantitative easing.
Quantitative easing
Quantitative easing is a process whereby the Bank of England, under instructions from the Treasury, buys up existing bonds in order to add money directly into the financial system. The process of doing this is called open market operations, and it is regarded as a last resort when low interest rates fail to work.
When interest rates approach zero, but an economy remains in recession, further interest cuts are impossible. This situation faced central bankers in early 2009. Interest rate policy in these circumstances becomes impotent, as nominal interest rates cannot fall below zero. This, together with cash hoarding by individuals, corporations and commercial banks, resulted in liquidity being trapped in the banking system. In this situation quantitative easing may be necessary to boost liquidity and stimulate lending.
Quantitative easing involves the following steps:
- The Bank of England purchases existing corporate and government bonds held by banks and corporations with electronic money, rather than notes and coins.
- These funds are credited to the bank and become a reserve asset.
- This means that, via the credit multiplier, banks can lend out to corporate and individual customers.
- The hope is that lending starts to flow, which will lead to an increase in household and corporate spending, and aggregate demand. This, it is argued, will help pull an economy out of recession.
Source - http://www.economicsonline.co.uk/Global_economics/Monetary_policy.html
Question: with the BCJ buying more Japanese government bonds (JGBs), how has this affected the yield on these bonds?
Question: What is the implication of the BCJ paying a negative interest rate on overnight deposits?
Evaluation of monetary policy
The advantages
1. Evidence shows that, in normal conditions, interest rates have a direct and powerful effect on household spending, which suggests that UK consumers are highly interest rate elastic.
2. The Bank of England’s Monetary Policy Committee is independent from government and can make decisions free from political interference.
3. Interest rates can be adjusted on a monthly basis, which contrasts with discretionary fiscal policy which cannot be adjusted at such regular intervals.
4. While the full effects of interest changes may not be experienced for up to a year, there is often an immediate effect on confidence. The time-lag on output is estimated to be around one year, and on the price level, around two years.
The disadvantages
1. There are still time lags to see the full effects, and there are some negative effects.
2. Raising interest rates can negatively affect on investmentspending and the housing market, and the exchange rate and hence the balance of payments.
3. There is also the problem of the dual economy - are high rates set for the booming service sector, or low rates for the depressed manufacturing and export sector?
4. The money supply is difficult to control in practice, so controlling interest rates is preferable.
5. Interest rates may fall to very low levels during a deep recession, and while the demand for credit may rise, the supply may become trapped in the system, known as the liquidity trap.
Source - http://www.economicsonline.co.uk/Managing_the_economy/Monetary-policy.html
Evaluating the effectiveness of monetary policy
Monetary Policy: The best case scenario
Monetary Policy: The negative real shock dilemma
When the Fed does too much
The Fed as lender of last resort: Moral hazard & systemic risk
Files to download
monetary_system.ppt2.5. Inflation_Targeting.pptReport abuse