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Monetary Policy
Monetary Policy
1
Goals of Monetary Policy
• Price stability (Low and stable inflation)
• High employment
• Economic growth
• Financial market stability
• Interest-rate stability
• Foreign exchange market stability
2
Hierarchical Mandate vs
Dual Mandate
• Hierarchical mandate
Set price stability as a primary goal
May make central bank behave as “inflation nutter”
• Dual mandate
Set two co-equal objectives: price stability and
maximum employment
3
Goals in the real world?
Bank of Thailand
Federal Reserve
4
The Bank of Thailand
Source: www.bot.or.th 5
The Bank of Thailand
Source: www.bot.or.th
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/AnnounceMPC/AnnouncementMPCTarget_2021.pdf
https://www.bot.or.th/English/MonetaryPolicy/MonetPolicyKnowledge/Pages/Target.aspx
6
7
ECB
8
Inflation Targeting
• Public announcement of medium-term numerical
target for inflation
• Institutional commitment to price stability as the
primary, long-run goal of monetary policy and a
commitment to achieve the inflation goal
• Information-inclusive approach in which many
variables are used in making decisions
• Increased transparency of the strategy
• Increased accountability of the central bank
Inflation Targeting
• Advantages:
Does not rely on one variable to achieve target
Easily understood
Reduces potential of falling in time-inconsistency trap
Stresses transparency and accountability
• Disadvantages:
Delayed signaling
Too much rigidity
Potential for increased output fluctuations
Low economic growth during disinflation
Linkages Between Central Bank Tools, Policy
Instruments, Intermediate Targets, and Goals of
Monetary Policy
Source: www.focus-economics.com
US Policy Rate
https://www.bot.or.th/English/FinancialMarkets/MonetaryOperations/Pages/default.aspx
19
Source: www.bot.or.th
Contractionary Accommodative
Monetary Policy (Expansionary)
Monetary Policy
Hawk Dove
Hawkish Dovish
20
Transmission mechanism
21
Source: www.bot.or.th
Transmission mechanism
22
Source: www.bot.or.th
Transmission mechanism
23
Source: www.bot.or.th
Transmission mechanism
24
Source: www.bot.or.th
Transmission mechanism
25
Source: www.bot.or.th
Transmission mechanism
26
Source: www.bot.or.th
Market for Reserve and short-term
interest rate
27
Demand for Reserves
28
Supply for Reserves
• Total supplied reserves
= Non-borrowed reserves
+
Interest rate Borrowed reserves
• Discount rate is cost of borrowing
Discount from the Fed
rate
• Borrowing from central bank is a
id Rs substitute for borrowing from other
banks
• If iff < id, then banks will not borrow
from the central bank and borrowed
reserves are zero The supply
curve will be vertical
• As iff rises above id, banks will
borrow more and more at id, and re-
NBR Quantity of Reserves (R) lend at iff The supply curve is
horizontal at id
29
Interest
rate
Rs = Rd
30
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Forward guidance
31
Bank of Thailand Tools
Lending facility
https://www.bot.or.th/English/FinancialMarkets/MonetaryOperations/Pages/default.aspx
32
Source: www.bot.or.th
Open Market Operations
id Rs
iff
Rd
34
Open Market Operations
id Rs
iff
Rd
35
Advantages of
Open Market Operations
36
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Forward guidance
37
Lending Facility
38
ECB Marginal Lending Facility
Lending Facility
Interest rate
i1 d Rs
iff
Rd
40
Lending Facility
Interest rate
i1ff = i1d Rs
Rd
41
Lending Facility
Interest rate
i1ff = i1d Rs
Rd
42
Lending Facility
Interest rate
i1ff = i1d
Rs
Rd
43
Lending Facility
Interest rate
id Rs
iff
Rd
Quantity of Reserves (R)
44
Credit Extended through Federal Reserve Liquidity Facilities
45
Source: federalreserve.gov https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
ECB
46
Source: Credit Agricole (August 4, 2021)
47
ECB - TLTRO III
The rate depends on banks’ lending
performance
• The favourable rate can be can be as low
as:
• -0.5% (Sep 2019 – Jun 2020),
• -1.0% (Jun 2020 – Jun 2022) and
• -0.5% (Jun 2022 – Dec 2024).
48
Advantages and
Disadvantages of Lending Facility
Advantages
• Used to perform role of lender of
last resort
• Used as a backup facility to prevent the federal funds rate from
rising too far above the target
Disadvantage
• Cannot be controlled by central bank; the decision maker is the
bank
• May result in moral hazard
49
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Forward guidance
50
Required Reserve Ratio
id Rs
i1ff • Demand for reserves
increases
iff
• Interest rate rises
Rd
Quantity of Reserves (R)
51
China Required Reserve Ratio
(%)
52
PBOC cut RRR to boost the economy
On 9 th July, China’s central bank, the PBOC, announced a 0.50 percentage point cut on required reserve ratio for
financial institutions (effective on 15th July after this reduction, the weighted RRR of financial institutions is 8.90%).
This 0.50 percentage point RRR cut will release about RMB1 trillion of funds, part of which will be used to replace
maturing MLF this month and make up the liquidity gap due to taxation later this month.
54
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Forward guidance
55
Interest on Reserve
Interest
rate
Rs = Rd
56
ECB Deposit Facility
Selected Liabilities of Federal Reserve
58
https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Liquidity provision
• Forward guidance
59
Large Scale Asset Purchase or
Quantitative Easing (QE)
https://www.youtube.com/watch?v=APqGR9s2Ywg&index=2&list=PLslyOrpjJ0z2du
ArbcMKan_xjl4lt07WW
60
Federal Reserve’s Liabilities
65
• At the Monetary Policy Meeting held on September 20 and 21, 2016, the
Bank decided to introduce "Quantitative and Qualitative Monetary
Easing (QQE) with Yield Curve Control.”
• The Bank commits itself to expanding the monetary base until the year-
on-year rate of increase in the observed consumer price index (CPI)
exceeds the price stability target of 2 percent and stays above the target
in a stable manner.
• The guideline for market operations specifies a short-term policy interest
rate and a target level of a long-term interest rate
The short-term policy interest rate: minus 0.1 percent
The long-term interest rate: 10-year Japanese government bon
yields remain more or less at the current level (around zero percent).
66
Source: Bank of Japan
Japanese Government Bond Yield
Curve (Oct 13, 2021)
Source: Bloomberg
Tools of Monetary Policy
• Open market operation
• Lending facility
• Reserve requirement
• Interest on reserve
• Large-scale asset purchase
• Forward guidance
68
Forward Guidance
• Speech
• Economic forecast
69
https://www.bot.or.th/Thai/PressandSpeeches/Speeches/Gov/SpeechGov_29Mar2021.pdf
Press Conference
70
Powell’s testimony to the Congress
• WASHINGTON, July 14 (Reuters) -
Federal Reserve Chair Jerome Powell on
Wednesday pledged "powerful support"
to complete the U.S. economic recovery
from the coronavirus pandemic, but faced
sharp questions from Republican
lawmakers concerned about recent
spikes in inflation.
• In testimony to the U.S. House of
Representatives Financial Services
Committee, Powell said he is confident
recent price hikes are associated with the
country's post-pandemic reopening and
will fade, and that the Fed should stay
focused on getting as many people back
to work as possible.
• Any move to reduce support for the
economy, by first slowing the U.S. central
bank's $120 billion in monthly bond
purchases, is "still a ways off," Powell
said, with 7.5 million jobs still missing
from before the pandemic.
Fed's Powell keeps to script on jobs recovery, feels heat on inflation front | Reuters
71
72
Lessons for Monetary Policy Strategy
from the Global Financial Crisis