roles of government

Question 1

What are the 4 economic goals for any modern economy?

Answer 1

• avoid too much inflation
• achieve full employment
• achieve sustainable economic growth-economic prosperity
• achieve a stable currency & strong international payments
position

Question 2

do banks need capital reserves to operate?

Answer 2

yes the reserves are set by law or convention

Question 3

monetary policy

Answer 3

it is concerned with control of amount of money in circulation i.e. money supply & its growth

Question 4

what is the purpose of monetary policy and how does it try to achieve this?

Answer 4

• Used (along with fiscal policy) to prevent wide swings from high peaks to low troughs in business cycles

• Monetary policy - directed at influencing level of interest rates
by targeting a base cash rate

• MP to try to stimulate economy - reduce interest rates
• Reducing interest rates should lead to better economic growth

• MP to try to slow down economic growth - increase interest
rates

Question 5

Relationship between Central Banks and

Governments

Answer 5

1. A Govt sets monetary policy & central bank implements it.
   Case in NZ up to 1986.
2. A Govt sets monetary objectives within certain constraints -
   central bank free to achieve objectives. Case in NZ now.
3. Monetary policy objective set in legislation - central bank free
   to follow whatever course of action it sees fit to achieve
   objective.
   Case in Euro area & Switzerland.

Question 6

what is NZ monetary policy objective?

Answer 6

objective under 1989 RB Act: to control inflation &

keep in band (stable prices)

Question 7

who has to agree on a Policy target agreement?

Answer 7

Treasurer & Governor

Question 8

what does OCR stand for?

Answer 8

Official Cash Rate

Question 9

What rate does the RBNZ target?

Answer 9

The official cash rate (OCR)

Question 10

Who controls the currency?

Answer 10

The RBNZ control the currency and sells (issues) cash to the banks that need it

Question 11

what does RBNZ stand for?

Answer 11

Reserve bank of NZ

Question 12

How many times a year is the OCR reviewed?

Answer 12

8 times a year & changes 25 bp or multiple.

Question 13

what rate does the reserve bank (RB) borrow & lend at?

Answer 13

borrows and lends at OCR

Question 14

WHAT RATE IS USED IF BANKS WANT CASH OVER NIGHT?

Answer 14

banks are charged interest rate 0. 50% above OCR

Question 15

what is reverse repurchase agreement?

Answer 15

purchase of securities
with the agreement to sell them at a higher price at a
specific future date. (RBNZ)

• For the party selling the security (& agreeing to buy it
back in future-bank) it is a repo; for the party on the other
end of the transaction (buying the security & agreeing to
sell in the future) it is a reverse repurchase agreement
.

Question 16

what are the Transmission Channels for monetary policy?

Answer 16

• Monetary policy channel
• Credit channel
• Wealth channel
• Foreign exchange channel

Question 17

Monetary policy channel

Answer 17

• increase in OCR by RBNZ
  (This is a tool of monetary policy)
  Then  increase in other S/T rates as price of money bid up,
  usually firstly S/T money market securities rates increase
  e.g. bank-accepted bills- large company borrowing.
  Then costs of funds for banks  so they increase deposit rates

Question 18

Credit channel

Answer 18

• increase in OCR rise in investment risk 
  bank lending may fall as borrowers come under stress due to
  higher interest costs so less credit available

Question 19

Wealth channel

Answer 19

• higher interest rates  decrease in asset
  values  loss of confidence for companies & households 
  decrease in economic activity

Question 20

Foreign exchange channel

Answer 20

• rise in OCR  higher exchange rate
   exports may fall due to higher cost whereas import prices fall
   harmful effect on balance of trade & economic output

Question 21

what are the immediate effect of Monetary policy channel?

Answer 21

• Short term interest rates e.g. overnight rates
• Wholesale S/T interest rates
• Foreign exchange rates

Question 22

what are the intermediate economic indicators Transmission Channels for monetary policy?

Answer 22

• money/credit- e.g. deposit rates, floating mortgage rates
• asset prices- bond and equity
• economic activity
• domestic demand

Question 23

what is fiscal policy and what are the instruments of it?

Answer 23

• Fiscal policy is concerned with govt.’s income & spending

• Tools (Instruments of fiscal policy) are:
– taxes,
– government spending or outlays &
– transfer payments

Question 24

what is a budget deficit?

Answer 24

where government spending > income (from

taxes & other sources e.g. interest, fees & fines)

Question 25

(1) what options can a govt use if its in a recession and wants to stimulate an economy but has a budget deficit?

Answer 25

one option is to borrow so its expenditure (G) increases * Borrowing from the domestic market * Borrowing funds from overseas markets the other option is govt. can reduce taxes to stimulate the economy

Question 26

(1) • Borrowing from the domestic market

Answer 26

central bank issues $100m govt bonds to borrow. - If govt spends all funds  no change in money supply.  Increase in real gross domestic product (GDP) in short-run If one-off borrowing, first, upward pressure on ST interest rates

Question 27

(1) • Borrowing funds from overseas markets

Answer 27

- initially, no impact on local borrowing, then either inflationary or growth creating (  in govt expenditure  increase in real gross domestic product (GDP) in S/T, & likely an increase in taxes paid) - Long term  the govt. debt has to be repaid with interest  contractionary impact on economic growth in L/T.

Question 28

(1) reduce taxes to stimulate the economy

Answer 28

expansionary fiscal policy-  consumers have more disposable income & in short-run, stimulatory fiscal policy will increase real GDP

Question 29

Contractionary fiscal policy in regards to budget deficit

Answer 29

it could cut its expenditure (spending) (G) overall .- or raise taxes  people will consume less as their net disposable income drops - or reduce transfer payments- targeted groups spend less

Question 30

whatis a budget surplus?

Answer 30

where income exceeds expenditure:

Question 31

(2) what are the govt options with a budget surplus?

Answer 31

• Options: Govt can retire debt or cut taxes or build up assets or increase govt. spending. • Impact of govt debt retirement on the economy & the financial system depends partly on who holds the debt securities

Question 32

(2)• Retirement of Govt Debt held by domestic market

Answer 32

interest rates may fall when govt security holders save the money they receive & govt need for funds drop. Also govt risk drops.

Question 33

(2) • Retirement of Govt Debt held by overseas institutions

Answer 33

more independent policy setting regime. Initially, no demand ↓ for domestic loanable funds  no impact on interest rates. - But retirement of debt makes govt safer (credit rating) & reduces need to service debt with interest so interest rates should fall 

Question 34

What are some issues relating to govt debt?

Answer 34

• Amount of debt usually compared with GDP- actual percentage an indication of easily it can be paid back • Preserving an efficient capital market - Argument for preserving the liquidity of key benchmark maturities • The reason for borrowing the money. - If it is borrowed for productive purposes e.g. to invest in infrastructure, then ability to repay may not be an issue.

Question 35

what relationship do GDP and employment have?

Answer 35

if GDP increases then employment increases and vice versa

Question 36

importance of fiscal policy?

Answer 36

• For countries continually running a budget deficit, risk profile of country higher, so too is interest rates, & money has to be borrowed from mainly off-shore to fund it.

Question 37

(3) functions of RBNZ?

Answer 37

* Monetary policy formulation(control of MS) & credit supply * Domestic market operations * Prudential supervision * Depository & settlement services * Currency * Foreign reserves management * Crisis management.

Question 38

(3) Domestic market operations

Answer 38

- operating as settlement bank for financial system. ESAS system processes settlement accounts. - over $25.9 billion worth of daily transactions in 2014

Question 39

(3) • Crisis management.

Answer 39

– Acting as lender of last resort for the financial system BUT no guarantee of banks’ deposits & no deposit insurance under usual conditions

Question 40

(3) Depository & settlement

Answer 40

- oversight of payments system

Question 41

(3) prudential supervision

Answer 41

supervisory role to all non-bank bank deposit takers (NBDTs) such as insurance companies, deposit-taking finance companies, non-deposit taking finance companies

Question 42

Basel I Guidelines on capital adequacy

Answer 42

• Capital adequacy focused on level of credit risk with defined capital & statement of minimum capital ratio, risk weighting of balance sheet assets & conversion of OBS items to ‘balance sheet equivalents’ & risk-weightings

Question 43

Basel II Capital Accord Framework- 1. Definition of bank capital

Answer 43

(1)Tier 1 - the core capital or highest quality (lowest risk) Characteristics: permanent commitment of funds i.e. readily available & rank behind claims of depositors if winding up bank e.g. • paid-up ordinary shares • retained earnings • current year’s earnings • non-cumulative, irredeemable preference shares

Question 44

2. Basel II Capital Accord is made up of three pillars:

Answer 44

Pillar One- capital adequacy * Pillar Two- supervisory review * Pillar Three- market discipline & disclosure

Question 45

Pillar 1: operational risk

Answer 45

- internal and external fraud - employment practices and workplace safety - clients, products and business practices - damage to physical assets - business disruption and system failures - execution, delivery and process management

Question 46

Pillar 2: Supervisory Review

Answer 46

•Supervisors to ensure banks have sufficient capital & to encourage development of, and improvement of existing risk management policies- four guiding principles

Question 47

Pillar 3: Market Discipline

Answer 47

• Designed to reinforce market discipline in banks’ capital adequacy • Note NZ has been leader in this aspect- requiring banks to disclose quarterly relevant & quantitative info relating to their risks, & capital adequacy

Question 48

two possible ways banks can increase capital ratio?

Answer 48

1. Find more capital - could involve rights issue, reducing dividends, raising money through other forms e.g. non-cumulative perpetual preference shares 2. Reduce assets - selling off subsidiaries, securitisation of loans.