Monetary Policy: Implementation Flashcards
Bank Regulation I
A commercial bank can create a new loan without having any CB reserves in advance: if subsequent transactions create a need for reserves then the bank can obtain them.
When a bank creates a loan, it is not lending out _________ (you and I do not have accounts with the central bank). Nor is it lending out someone else’s deposit.
In the United Kingdom, now, there is no ____________ _________
_________ requirement, i.e. there is no rule that commercial banks have to keep an amount of reserves equal to x% of deposits. Some countries do have such rules, but they typically apply with a _____ ____.
A commercial bank can create a new loan without having any CB reserves in advance: if subsequent transactions create a need for reserves then the bank can obtain them.
When a bank creates a loan, it is not lending out reserves (you and I do not have accounts with the central bank). Nor is it lending out someone else’s deposit.
In the United Kingdom, now, there is no regulatory deposit reserve requirement, i.e. there is no rule that commercial banks have to keep an amount of reserves equal to x% of deposits. Some countries do have such rules, but they typically apply with a time lag.
Bank Regulation II
What does the absence of a mandatory deposit:reserve ratio not mean?
What are the Prudential Regulation Authority responsible for in England?
What do risk weighting recognize?
The absence of a mandatory deposit:reserve ratio does not mean that banks are not regulated (or can do anything that they want). In the UK the Prudential Regulation Authority (a sub-unit of the Bank of England) is responsible for monitoring banks and financial institutions and applying the relevant regulations.
Risk weighting recognizes that a government bond is safe, a mortgage is a bit less safe, unsecured loans are still less safe etc., in relative terms.
Government Bonds I
What is a government bond?
What is different about it?
High bond prices lead to…
A government bond is a financial asset issued by the government. Unlike many assets, the bond has a fixed terminal value and newly-issued bonds are sold by auction.
For example, a bond might return a payment of £100 in one year’s time. Suppose that you bid (successfully) at £95. When the bond matures your return will be 100−95/ 95 = 5.3%
High bond prices lead to lower yield and low bond prices correspond to high yields.
Government Bonds II
What is the difference between the Primary and Secondary market?
What is a liquid asset?
Difference between savings and government bond?
When a new bond is issued it is old via auction to the primary market, which is only accessible to a small number of specialist dealers, typically.
The secondary market features transactions between parties other than the government, involving existing bonds rather than new issues.
2A liquid asset is one which can be sold quickly at close to fair value.
The secondary market tends to be very liquid, which further adds to the ‘safety’ and usefulness of government bonds.
Government bonds are tradeable so can be given away whereas savings is only in ones name.
Repurchase agreements I
What is it?
We have seen that when a commercial bank needs to borrow reserves from the central bank, for a short period of time, the Bank of England ‘standard’ is to agree a one-week repurchase agreement.
Outright asset purchases
A repurchase agreement is a suitable means for a particular _____________ _____ to temporarily acquire ______________ _______ ______ _________. There will be periods when the banking system as a whole requires a higher level of reserves.
In this case the central bank can increase the total amount of reserves by buying ______ from banks.
A repurchase agreement is a suitable means for a particular commercial bank to temporarily acquire additional central bank reserves. There will be periods when the banking system as a whole requires a higher level of reserves - e.g. ?
In this case the central bank can increase the total amount of reserves by buying assets from banks.
Setting interest rates
In the previous example, the central bank was able to change the level of reserves held by the banking system (and note that the level of reserves could have been reduced by _________ a _____ initially held by the -bank)
- If the level of reserves in the system is low (relative to the amounts required by banks) then the rate paid on the interbank market will be bid ___________(and there could be a risk of payments not being honoured) - buying bonds (at higher prices) will increase the amount of ___________ and lower _________ ______.
- If the level of reserves in the system is high (relative to the amounts required by banks) then the rate paid on the interbank market will be bid __________ - selling bonds (at lower prices) will ___________ the amount of reserves and _________ interest rates.
In the previous example, the central bank was able to change the level of reserves held by the banking system (and note that the level of reserves could have been reduced by selling a bond initially held by the central bank)
- If the level of reserves in the system is low (relative to the amounts required by banks) then the rate paid on the interbank market will be bid upwards (and there could be a risk of payments not being honoured) - buying bonds (at higher prices) will increase the amount of reserves and lower interest rates.
- If the level of reserves in the system is high (relative to the amounts required by banks) then the rate paid on the interbank market will be bid downwards - selling bonds (at lower prices) will decrease the amount of reserves and increase interest rates.
Setting interest rates II
The above supposes that the demand and supply for reserves is roughly balanced (or will be after asset purchases or sales), such that the central bank can nudge the interest rate/yield in
the desired direction.
When supply is much greater than demand the interbank interest rate will fall towards ____- one way to prevent this (if desired) is to set a ‘______ ’ by ________ _________on ________.
Both the Bank of England (via the Operational Standing Facility) and the European Central Bank set a ‘corridor’ for overnight deposit and loan rates. The OSF pays 0.25 percentage points less than Base Rate on deposits and charges 0.25 percentage points above Base Rate on loans.
Setting interest rates II
The above supposes that the demand and supply for reserves is roughly balanced (or will be after asset purchases or sales), such that the central bank can nudge the interest rate/yield in
the desired direction.
When supply is much greater than demand the interbank interest rate will fall towards zero - one way to prevent this (if desired) is to set a ‘floor’ by paying interest on reserves.
Both the Bank of England (via the Operational Standing Facility) and the European Central Bank set a ‘corridor’ for overnight deposit and loan rates. The OSF pays 0.25 percentage points less than Base Rate on deposits and charges 0.25 percentage points above Base Rate on loans.
The policy of so-called Quantitative Easing is the same as ________ ________ ____________ on the ____________ _______, in principle, but there are some particularities related to the ______, ___________ , __________and _____________-.
The policy of so-called Quantitative Easing is the same as outright asset purchases on the secondary market, in principle, but there are some particularities related to the scale, context,
purpose and implementation.
