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Monetary PolicyChanges in Monetary Policy Tools
in order to affect Aggregate Expenditures
Increase AE
Decrease AE
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Monetary Policy Objectives
Maintain “stable prices” = inflation below 3%.
today:?www.mnb.huMaintain “sustainable economic
growth” = Output Growth at least 3%
Today:?
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GDP - Hungary2007 1.Q.: 102,3%2008 1.Q.: 101,9%
2009 1.Q.: 93,3%2009 4.Q.: 92,8%
2010 1.Q :100,1%2010 2.Q: 100,9%
-16-14-12-10-8-6-4-2024681012
-16-14-12-10-8-6-4-202468
1012
01 Q
101
Q3
02 Q
102
Q3
03 Q
103
Q3
04 Q
104
Q3
05 Q
105
Q3
06 Q
106
Q3
07 Q
107
Q3
08 Q
108
Q3
09 Q
109
Q3
10 Q
1
% (A
nnua
lrate
of gr
owth)
% (A
nnua
lrate
of gr
owth)
Households' consumption Government consumptionGross fixed capital formation Inventories and statistical discrepanciesNet exports GDP growth
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Monetary policy goalsPrice stabilityHigh employmentEconomic growthInterest rate stabilityStability of financial marketsStability in foreign exchange
markets
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Monetary Policy Tools1. Open Market Operations:
Buying or Selling Bonds to the public.
2. Required Reserve Ratio. 3. Changing the Discount Rate.4. Changing Margin Requirements5. Using “Moral Suasion”.
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1. Open Market Operations
Name: from the Bank of England
Refinancing loans only to special institutions
Government papers are on the open market, for everyone
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1. Open Market Operations
To sell open market instruments =
Reduce national bank money
To buy open market instruments=
Create money
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1. Mechanism of Open Market Operations
The entire banking system consists of only five banks
and they hold their reserves at the Fed.
Example r = 20%
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Banking System DepositsBank 1 has
10,000Bank 2 has
30,000Bank 3 has
40,000Bank 4 has
15,000Bank 5 has
5,000
D=100,000d1= 10,000d2= 30,000d3= 40,000d4= 15,000d5= 5,000
Total deposits in the banking system are $100,000
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Reserves = 20% of Deposits
Bank 1 has 10,000 (0.2) = 2,000 in reserves
Bank 2 has 30,000(0.2) =6,000 in reserves.
Bank 3 has 40,000(0.2) =8,000 in reserves
Bank 4 has 15,000(0.2)=3,000 in reserves
Bank 4 has 5,000(0.2)=1,000 in reserves
All BanksReserves
R=20,000
Total reserves in the banking system are $20,000
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Ms = Deposits + Currency outside banks.
All BanksReserves
R=20,000
All BanksDeposits
D=100,000d1= 10,000d2= 30,000d3= 40,000d4= 15,000d5= 5,000
r = 0.2R=20,000 D=100,000
Ms = 100,000
L= 80,000
80,000 are in loans.
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The Fed’s AccountFederalReserveBank
R=20,000Bank 1= 2,000Bank 2= 6,000Bank 3= 8,000Bank 4= 3,000Bank 5= 1,000
Bonds
Assets Liabilities
The Fed holds Government bonds as part of their Assets.
Bank’s reserves are liabilities to the Fed
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The Fed Buys $100 in Bonds From Mr. Anderson
5000Bonds
Assets Liabilities
100 Bond Mr. Anderson
5100Bonds
Fed pays with a check $100
FED
R=20,000Bank 1= 2,000Bank 2= 6,000Bank 3= 8,000Bank 4= 3,000Bank 5= 1,000
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Mr. Anderson Deposits the Fed’s Check at Bank
1Fed pays with a check
New depositAt bank One$100
All BanksDeposits
D=100,000d1= 10,000d2= 30,000d3= 40,000d4= 15,000d5= 5,000
$100 d1=10,100
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R=20,000Bank 1= 2,000Bank 2= 6,000Bank 3= 8,000Bank 4= 3,000Bank 5= 1,000
A Bond Purchase Increases Bank’s Reserves
5000Bonds
Assets Liabilities
100 Bond Mr. Anderson sells bond
5100Bonds
Bank 1 presents the checkto the Fed for clearing
$100
FED
=2,100
Fed credits Bank One’s reserves
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With $100 in extra reserves…
1r
D D = x D R
10.2
D D = x 100
D D=500
Deposits increase by 500 when reserves increase by 100.This 500 includes a 400 increase in loans.
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When Bank One’s Reserves Increase
Bank One holds now more reserves than required,
Bank One will make more loans To other banks To the public
The loans generated become new deposits at other banks which keep 20% as reserves and loan the rest…
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The Effect of a 100 purchase of bonds by the Fed.
All BanksReserves
R=20,100
All BanksDeposits
D=100,500d1= 10,100d2= 30,100d3= 40,100d4= 15,100d5= 5,100
r = 0.2R=20,100D=100,500
Ms = 100,500 and 80,400 of that is loans.
Note that deposits increased in all banks…
L= 80,400
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Three Kinds of ReservesRequired Reserves (RR). The amount
that must be held by law, the required reserve ratio times deposits:
RR = r(D)Actual Reserves (AR). The amount of
reserves actually held by the bank. This could be higher or lower than RR.
Excess Reserves(ER). Any amount held above required reserves.
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Deposits = 10,000Reserves = 2,000
r=20%
New Deposit= 100
New Loan = 80Loans = 8,000
Deposits = 30,000Reserves = 6,000
r=20%
New Deposit= 80
New Loan = 64
Loans = 24,000
Bank One
Bank Two
Hold as reserves=16
The Fed’s Purchase Step by Step
Deposits = 40,000Reserves = 8,000
r=20%
New Deposit= 64
New Loan = 64
Loans = 32,000
Bank Three
Hold as reserves = 12.8
After three steps, deposits have increased by: 100 + 80 + 64 = 244…
Hold as reserves=20
Becomes a new deposit
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At the end of the Money Multiplier Process…
D = 100,000R = 20,000r=20%
L = 80,000
All BanksBefore
All BanksAfter
D = 100,500R = 20,100r=20%
L = 80,400
D R=100; D D=500; D L = 400
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In SummaryWhen the Fed
Buys BondsNew Reserves
become available for banks to loan out
Money is createdThe Money
Supply increases.
D = 100,000R = 20,000r=20%
L = 80,000
DD = DR(1/r) DR = Fed’s Purchase R=20%
DL = DD - DR
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All Short term interest rates change with the fed funds rate
Fed Injects/ erase new reserves to the banking system
1. Open Market OperationsFed
buys/sells bonds from the public or banks Money/Credit
easier/harder to get
Federal Funds Rate Decreases/Increases
Long Term interest rates change
Investment Changes
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2. Reserve ratio1913 FEDTo ensure:
banks’ liquidityTo defend depositors
Now:To serve monetary policyUsually differentiated rates
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2.Changing the Required Reserve Ratio.
D = 100,000R = 20,000r=20%
L = 80,000
All Banks
r = 10%AR = 20,000RR = 10,000ER = 10,000
New loan = 10,000 New Deposit Hold 10%=1,000New loan = 9,000 New Deposit Hold 10%= 900New loan = 8100 New Deposit Hold 10%=810
DD = DR(1/r) DD = 10,000(1/0.1)
DD = 100,000 D = 200,000
New loan …
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2. Changing the Required Reserve
Ratio.
D = 100,000R = 20,000r=20%
L = 80,000
All BanksBefore
The Fed Decreases r to 10%
D = 200,000R = 20,000
L = 180,000
Reserves did not change.Now 20,000 in reserves must be 10% of total deposits
20,000= (0.1) D D = 20,000/0.1D= 200,000
r=10%
All BanksAfter
Reserve Required RatioWhere to find?
www.federalreserve.gov
www.mnb.hu
.
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3. The Discount Rate: d
The interest rate charged by the Federal Reserve Bank on
loans to Banks.
d =5%
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Decreasing the Discount Rate d
When funds from the Fed become “cheaper” banks find it less necessary to hold excess reserves…
In case of need, banks can borrow funds from the Fed at low d.
Banks are induced to borrow from the fed rather than keep excess reserves to cover emergencies…
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A decrease in d: two possible scenarios
1. Banks borrow more reserves from the Fed
Reserves in the banking system increase: the Fed injects new reserves which generate new loans and new deposits
2. Decreases Excess Reserves Banks hold on to less excess reserves
and thus make more loans generating new deposits.
The Money Supply Increases
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4. Margin Requirements
The fraction of the stock’s price that must be put up by the person buying the stock:
the Down payment
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Margin RequirementsSelected Years
5019949019585019745019536519707519477019631001945501962751942701960501940
MarginYearMarginYear
WARIn
flatio
n
Recessi
on
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5. Moral Suasion and the Gentlemens Agreements:
The Omen of things to come
“Those found cheating will be suspended from school”
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Fed’s ActionsPublic Statement
“The Fed hopes that banks show more restraint in providing consumer credit, because inflation is a problem”
Official Fed Policy Statements “The Fed will raise interest rates by
25 basis points”Direct Appeals
Letters to bank presidents.