March 24 & 31 Flashcards
(38 cards)
any central bank has ____ options for their approach in implementing monetary policy
two
- target MONEY SUPPLY
- target INTEREST RATE
but for a given MD curve, both can’t be targeted independently
BoC could attempt to shift MS curve directly…
changing the amount of currency in circulation by SELLING GOV SECURITIES in the financial markets
ie. using currency to buy $100 000 worth of gov bonds
^ this increases the amount of cash reserves in banking system by $100 000
^ commercial banks will then be able to lend out these new reserves, increasing the amount of cash reserves
what does the BoC choose to do when carrying out monetary policy?
targets the INTEREST RATE
why does BoC target the interest rate and not the money supply?
- BoC can CONTROL a particular interest rate
- UNCERTAINTY about SLOPE and POSITION of MD curve doesn’t prevent BoC from establishing its desired interest rate
- BoC can easily COMMUNICATE its interest rate policy to the public
overnight interest rate
interest rate at which major financial institutions BORROW and LEND one-day (“overnight”) funds among themselves
^ banks that NEED CASH because they’ve run short of reserves can BORROW in the overnight market from other banks that have excess reserves (these banks LEND)
^ BoC sets a TARGET LEVEL for that rate
what else does the BoC announce along with its target for overnight interest rate?
- rate that it charges for LOANS (bank rate)
- rate that it pays for DEPOSITS
BoC bank rate
the rate the BoC charges for LOANS
0.25 percentage points above the target rate
bank promises to LEND at this bank rate ANY AMOUNT that COMMERCIAL BANKS want to borrow
rate the BoC pays for deposits
bank offers to BORROW (accept deposits) in UNLIMITED AMOUNTS from commercial banks and pay them an interest rate of 0.25 percentage points below target
the actual overnight interest rate stays within what range of the target rate?
0.5 percentage points
how can the BoC more or less control the overnight interest rate?
- setting a target for the overnight interest rate
^ say it’s 2%
- establishing a bank rate 0.25% above this target
^ means that no one will borrow from anyone charging more than target + 0.25% (ie. 2.25%)
- establishing a borrowing rate 0.25% below this target
^ means that no one will lend excess reserves for anything less than target = 0.25% (ie. 1.75%)
what will BoC do if it wants to cool down the economy?
will make it more expensive to borrow and more attractive to deposit
do this by manipulating the bank rate
what do we mean when we say “the money supply is endogenous”?
endogenous means the money supply and the interest rate move together
when the BoC changes its target for overnight interest rate, the change in the actual overnight rate happens ALMOST INSTANTLY
changes in other market interest rates happen within a day or two
firms and households then begin to adjust their behaviour
how long does it take to change the overnight interest rate?
happens almost instantly after the BoC changes its target
how long does it take for commercial banks to adjust to the new overnight interest rate?
a day or two
as the demand for new loans gradually adjusts, commercial banks often find themselves…
demand for new loans adjusts ie. lower interest rates = more demand
so commercial banks find themselves in NEED OF MORE CASH RESERVES with which to make loans
after shift in market interest rate, commercial banks often need more reserves with which to make loans - how do they solve this problem?
they SELL SOME OF THEIR GOV SECURITIES to the BoC in exchange for cash
use this cash to extend new loans
purchase or sale of gov securities on open market by central bank is an OPEN-MARKET OPERATION
by what type of operation does the BoC change the amount of currency in circulation?
open-market operations
(BoC reduces target interest rate, commercial banks reduce their interest rates, households and firms desire more loans, commercial banks sell gov securities to BoC, this ups their cash reserves and they extend new loans)
money supply is endogenous - summary
as the bank changes its target for the overnight interest rate…
- other interest rates change
- bank lending changes
- banks’ demand for currency changes
banks respond by supplying currency or buying currency from commercial banks
open-market operations
the amount of currency in circulation is endogenous - explain
amount of currency in circulation responds to changes in interest rates
this isn’t directly controlled by the BoC - but the BoC creates environment where commercial banks have incentives to create deposit money
what controls the amount of currency in circulation?
(not directly controlled by BoC)
determined by economic decisions of households, firms and commercial banks
BoC is seen as ______ in its decisions regarding the money supply
passive
(it conducts open-market operations to accommodate the changing demand for currency coming from the commercial banks)
if commercial banks need more cash…
the BoC buys their gov securities
OPEN MARKET PURCHASE
if commercial banks have excess cash…
the BoC sells government securities
open market sale
expansionary monetary policy in relation to target interest rate
expansionary monetary policy occurs when BoC REDUCES its TARGET for the overnight interest rate
^ eventually increases MS
