The Tools of Monetary Policy
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1 The Tools of Monetary Policy MBMM Lecture Petar Stankov 02 Dec P. Stankov (CERGE-EI) Lecture Dec / 8
2 Outline 1 How Do the Tools of Monetary Policy Work? P. Stankov (CERGE-EI) Lecture Dec / 8
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 Dec / 8
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 Dec / 8
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 Dec / 8
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 Dec / 8
7 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? P. Stankov (CERGE-EI) Lecture Dec / 8
8 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? P. Stankov (CERGE-EI) Lecture Dec / 8
9 How Does Reserve Requirement Instrument Work? Suppose the Central bank increases RRR? Interbank interest rate (FED Funds Rate), P. Stankov (CERGE-EI) Lecture Dec / 8
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 Dec / 8
11 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? P. Stankov (CERGE-EI) Lecture Dec / 8
12 How Does the Discount Rate Instrument Work? Suppose the Central bank decreases the discount rate? P. Stankov (CERGE-EI) Lecture Dec / 8
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 Dec / 8
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 Dec / 8
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 Dec / 8
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 Dec / 8
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 Dec / 8
18 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? P. Stankov (CERGE-EI) Lecture Dec / 8
19 How Do the Open Market Operations Work? Suppose the Central bank buys some G bonds? P. Stankov (CERGE-EI) Lecture Dec / 8
20 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 Dec / 8
21 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 Dec / 8
22 Advantages of Open Market Operations P. Stankov (CERGE-EI) Lecture Dec / 8
23 Advantages of Open Market Operations 1 Complete control over the volume of money given to the commercial banks P. Stankov (CERGE-EI) Lecture Dec / 8
24 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 Dec / 8
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 3 Quick: a matter of day in US (a week in Europe) P. Stankov (CERGE-EI) Lecture Dec / 8
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