Professional Documents
Culture Documents
Monetary Economics
Chapter 6
Central Bank and the Conduct
of the Monetary Policy
Main Textbook:
Mishkin, Frederic S. (2009). The Economics of Money, Banking & Financial Market,
9th Edition, New York : Pearson Addison Wesley
http://www.cwu.edu/~saunders/ec330/ec330ppt.html
http://databank.worldbank.org/data/home.aspx
LEARNING OBJECTIVES
Monetary Policy
To overcome inflation
Contractionary / Restrictive / Tight monetary policy
Tools used will reduce Money Supply in the
economy. This is aimed at reducing the pressures
of inflation in an economy
To
Quantitative
Qualitative
Selective credit
control
Open market
operations (OMO)
Moral Suasion
Legal reserve
requirements
Special Directive
Funding
Interest rate
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1. Open
marke
operations
2. Legal
reserve
requireme
nts
3. Funding
4.
Discount
rate
5. Interest
rate
1. Selective credit
control
2. Moral Suasion
3. Special directive
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2. Moral suasion
The central bank will persuade the commercial bank to restrict
their lending policy.
3. Special directives
The central bank may set up directives and instructions to
banks to reduce the volume of loans given to clients.
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3. Funding- Buying long term bonds shorten the duration of time for loan
repayment allows them to increase the volume of loans
Buying bonds, so people will sell illiquid securities which causes general publics
expenditure to increase.
4. Discount rate / Bank rate A decrease in discount rate/ bank rate
Imposed by the central bank on discount houses, thus borrowing becomes
more cheaper and demand for loans will be increased.
It will affect all other rates in the market to allow more circulation of money in
the economy.
5. Interest rate policy A decrease in interest rate
1. The central bank will persuade commercial banks to lower their interest rate
on deposits.
This will reduce total savings and increase the level of demand for money.
2. When all banks decrease interet rate, the cost of credits to the public will be
reduced.
This will increase the level of demand for money and purchasing activities.
Unemployment will be reduced.
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Qualitative
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1. Price stability
(the primary goal)
6. Stability in foreign
exchange markets
2. High employment
(output stability)
5. Stability of financial
markets
3. Economic growth
4. Interest rate
stability
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For
investors
and
business
entrepreneurs,
postponement
projects
will
create
massive
unemployment and slowing the growth of living
standards..
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All
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Merits
1. The central bank has complete control power over
the volume of OMOs.
2. OMOs are flexible and precise.
3. OMOs are easily reserved.
4. OMOs can be implemented quickly.
Demerits
1. the confusion about the central banks intention that
may be created by the OMOs
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Merits
1. The central bank can use it to perform its role as a
lender of last resort.
Demerits
1. Cannot be controlled by the central bank; the
decision maker is the bank
2. May encourage banks to take more risk.
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Merits
1. RR is a powerful tool to affect money supply.
2. Small changes in the RR will result in large changes in
the money supply.
3. RR policy affects all banks equally.
Demerits
1. The raising the RR can cause immediate liquidity
problem in banking institutions.
2. Fluctuating RR would create more uncertainty and lead
the liquidity management to be more difficult.
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