MONETARY POLICY
A few key ideas – pairs edition
Interest Rate…Yes or No?

Investment
 Do
businesses invest more when the interest rate is high?
 No!

Bonds
 Do
people demand more bonds when the interest rate
is high?
 Yes!
 Does
 No!
an increase in the interest rate help bond owners?
(It helps bond BUYERS though)
Interest Rate…Yes or No?

Investment
 Do
businesses invest more when the interest rate is high?
 No!

Bonds
 Do
people demand more bonds when the interest rate
is high?
 Yes
 Does
 No!
an increase in the interest rate help bond owners?
(It helps bond BUYERS though)
3 Tools of Monetary Policy

Reserve requirement (RR) - The % that banks must hold in
reserve and cannot loan out. The RR is 10% in the US.
To increase money supply, __________RR. (increase or decrease?)
 To decrease money supply, __________ RR.


Discount rate (DR) - The interest rate that the central bank
charges commercial banks.
To increase money supply, __________ DR.
 To decrease money supply, __________ DR.


Open Market Operations (OMO) - When the central bank
buys or sells bonds (treasuries) in the open market.
To increase money supply, they should __________ bonds.
 To decrease money supply, they should __________ bonds.


To fix a recessionary gap, a central bank should ____ the
money supply.
MONETARY
POLICY
*Effects*
(For now, don’t worry about
“excess reserves increasing/
decreasing” parts)
RECAP: THE TWO MULTIPLIERS
KEYNESIAN MULTIPLIER



MONEY MULTIPLIER
(1-MPC) = ???
Which is more associated with fiscal policy?
Which is more associated with monetary policy?
The Money Multiplier
(Based on a 10% Reserve Requirement)
Inflation Targeting

Where do countries often try to keep inflation?
 Around
2%
HOW CAN FISCAL AND MONETARY POLICIES
AFFECT NET EXPORTS?
EASY MONEY
EXPANSIONARY FISCAL
Gov’t spending has what effect on investment spending & net exports?

DECREASE
___________ IN NET
EXPORTS?
WHY?

INCREASE IN NET
___________
EXPORTS?
WHY?
Consider:
• (1) affects on supply/demand for
money
• (2) change in interest rates
• (3) foreign demand for money
• (4) currency
appreciation/depreciation
• (5) affect on Xn
Net Export Effect & FISCAL Policy
Review: How would each of these
affect Australia’s economy? (AD & AS)

Australia’s currency strengthens in value compared to Euro
AD – decreases Xn
 AS – should increase


Australia’s currency weakens in value compared to Euro
AD – increases Xn
 AS – should decrease


Other countries experience a recession
AD – decreases Xn
 AS – ?
(perhaps increases if deflation In other countries occurs)


Other countries experience economic growth
AD – increases Xn
 AS – ?
(perhaps decreases if inflation In other countries occurs)

Central Banks as…
Regulators of
Commercial Banks I
 CAMELS (for banks)
Condition (capital
adequacy)
 Asset quality
 Management
 Earnings
 Liquidity
 Sensitivity to Market Risk

Central banks are also supposed
to protect the consumer!!!
Regulators of Commercial
Banks II (info from The Fed)
 5 Cs (from sample size of
borrowers)





Capacity (borrower’s
ability to pay)
Collateral (if borrower
doesn’t pay)
Condition (borrower’s
circumstances…how much $
is expected to come in)
Capital (do borrower’s
liabilities outweigh assets?)
Character (borrower’s
payment history/credit
report)
Central Banks as…

Bankers to governments!
 Holding/investing
money used for government
operations (collected through taxes)
 Selling government securities (raises money for gov’t)
And finally…

A definition of Interest (Thanks Wikipedia!)
A
fee paid by a borrower of assets
to the owner as a compensation for
the use of the assets. It is most
commonly the price paid for the use
of borrowed money or money
earned by deposited funds.