The Tools of Monetary Policy
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1 The Tools of Monetary Policy 1BP570 Lecture 4.1. Petar Stankov 15 Apr P. Stankov (CERGE-EI) Lecture Apr / 9
2 Outline 1 How Do the Tools of Monetary Policy Work? P. Stankov (CERGE-EI) Lecture Apr / 9
3 What Does a Central Bank Do? The main goals of the central bank are: use monetary policy tools to prevent crises 1 set reserve requirements 2 determine discount rate 3 make open market operations intervene when crises occur P. Stankov (CERGE-EI) Lecture Apr / 9
4 What Does a Central Bank Do? The main goals of the central bank are: use monetary policy tools to prevent crises 1 set reserve requirements 2 determine discount rate 3 make open market operations intervene when crises occur What is the impact of each of these tools on bank reserves? P. Stankov (CERGE-EI) Lecture Apr / 9
5 What Does a Central Bank Do? The main goals of the central bank are: use monetary policy tools to prevent crises 1 set reserve requirements 2 determine discount rate 3 make open market operations intervene when crises occur What is the impact of each of these tools on bank reserves? Why do we care about bank reserves? P. Stankov (CERGE-EI) Lecture Apr / 9
6 What Does a Central Bank Do? The main goals of the central bank are: use monetary policy tools to prevent crises 1 set reserve requirements 2 determine discount rate 3 make open market operations intervene when crises occur What is the impact of each of these tools on bank reserves? Why do we care about bank reserves? Money supply. P. Stankov (CERGE-EI) Lecture Apr / 9
7 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? P. Stankov (CERGE-EI) Lecture Apr / 9
8 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? P. Stankov (CERGE-EI) Lecture Apr / 9
9 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? Interbank interest rate (FED Funds Rate), P. Stankov (CERGE-EI) Lecture Apr / 9
10 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? Interbank interest rate (FED Funds Rate), Ms. P. Stankov (CERGE-EI) Lecture Apr / 9
11 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? P. Stankov (CERGE-EI) Lecture Apr / 9
12 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? P. Stankov (CERGE-EI) Lecture Apr / 9
13 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? Interbank interest rate (FED Funds Rate), P. Stankov (CERGE-EI) Lecture Apr / 9
14 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? Interbank interest rate (FED Funds Rate), Ms. P. Stankov (CERGE-EI) Lecture Apr / 9
15 Why Does the Central Bank Need This Instrument? 1 A supporting source of liquidity for the commercial banks (1 to 1.5% points higher than the interbank interest rate) 2 A roof for the targeted interbank interest rate 3 A lender of last resort: prevent crises. P. Stankov (CERGE-EI) Lecture Apr / 9
16 Why Does the Central Bank Need This Instrument? 1 A supporting source of liquidity for the commercial banks (1 to 1.5% points higher than the interbank interest rate) 2 A roof for the targeted interbank interest rate 3 A lender of last resort: prevent crises. Disadvantages? P. Stankov (CERGE-EI) Lecture Apr / 9
17 Why Does the Central Bank Need This Instrument? 1 A supporting source of liquidity for the commercial banks (1 to 1.5% points higher than the interbank interest rate) 2 A roof for the targeted interbank interest rate 3 A lender of last resort: prevent crises. Disadvantages? Moral hazard. P. Stankov (CERGE-EI) Lecture Apr / 9
18 Lender of last resort in the US: The story behind: After the collapse of Lehman Bros. the interbank mkt froze: noone was lending to anyone the central bank needed to step in as the lender of last resort P. Stankov (CERGE-EI) Lecture Apr / 9
19 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? P. Stankov (CERGE-EI) Lecture Apr / 9
20 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? P. Stankov (CERGE-EI) Lecture Apr / 9
21 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? Interbank interest rate (FED Funds Rate), P. Stankov (CERGE-EI) Lecture Apr / 9
22 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? Interbank interest rate (FED Funds Rate), Ms. P. Stankov (CERGE-EI) Lecture Apr / 9
23 Advantages of Open Market Operations P. Stankov (CERGE-EI) Lecture Apr / 9
24 Advantages of Open Market Operations 1 Complete control over the volume of money given to the commercial banks P. Stankov (CERGE-EI) Lecture Apr / 9
25 Advantages of Open Market Operations 1 Complete control over the volume of money given to the commercial banks 2 Easy to reverse in case of overshooting P. Stankov (CERGE-EI) Lecture Apr / 9
26 Advantages of Open Market Operations 1 Complete control over the volume of money given to the commercial banks 2 Easy to reverse in case of overshooting 3 Quick: a matter of day in US (a week in Europe) P. Stankov (CERGE-EI) Lecture Apr / 9
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Stanford Graduate School of Business Syllabus and Course Outline Finance 347 - Money and Banking Professor Arvind Krishnamurthy, Rm E256 e-mail: a-krishnamurthy@stanford.edu Course Content: This course