Monetary Policy part 1

What is monetary policy?

It is the process by which government, central bank or other monetary authorities manages supply of money in economy

What is monetary theory?

It is the set of theoretical insights used in the process of designing monetary policy

What is fiscal policy?

It is the way that government conducts the process of borrowing, spending and taxation.

What does expansionary monetary policy?

Expansionary monetary policy increases the total supply of money in the economy.

What does contractionary monetary policy?

Contractionary monetary policy decreases the total money supply in the economy

How expansionary MP is conducted?

Expansionary policy is conducted by lowering interest rates

How contractional MP is conducted?

Contractionary policy is conducted by raising interest rates

Roles and responsibilities of central bank?

Provides a nominal anchor for the economy, Is ensuring domestic financial stability (lender of last resort, reducing or preventing banking and financial crises); Bank of note issue; Banker, Agent and Adviser to the Government; Bankers' Bank; Clearing Agent

What nominal anchor is?

Nominal anchor is a variable used in monetary policy, whose value is reported to the public and reflects (usually) medium-term targets of monetary policy.

Give examples of nominal anchor

Inflation rate Money supply Exchange rate

What are targeting regimes of monetary policy?

Long term objective Target market variable

What is target market variable and long-term objective of inflation targeting?

Interest rate on overnight debt / a given rate of change in the CPI

What is target market variable and long-term objective of Price Level Targeting?

Interest rate on overnight debt / A specific CPI number

What is target market variable and long-term objective of Monetary Aggregates

The growth in money supply / A given rate of change in the CPI

What is target market variable and long-term objective of Fixed Exchange Rate?

The spot price of the currency in both cases

What is target market variable and long-term objective of gold standard

The spot price of gold / Low inflation as measured by the gold price

What is target market variable and long-term objective of mixed policy

Usually interest rates / Usually unemployment + CPI change

What are the five key elements of

- Public announcement of medium-term numerical targets for inflation -Institutional commitment to price stability as the primary goal of monetary policy -Information strategy in which many variables are used for deciding about policy instruments -Increased transparency of the monetary policy strategy through communication with the public and the markets -Increased accountability of central bank

What are the core ingredients of inflatiom targeting?

- Commitment to a low and stable inflation rate - Commitment is publicly expressed in terms of announced numerical inflation target and the definition of relevant price index - Central bank has instrument independence

What are inflation price indices?

CPI and core measure of inflation

What is CPI?

CPI - (Consumer Price Index) measures changes of prices of basket of typical goods and services bought in the country

What is the core measure of inflation?

Excludes direct rate effects on CPI and excludes volatile components (food, energy)

What are the key aspects in fighting inflation?

- Clarification of the objectives of monetary policy - Adoption of institutional structures for the conduct of monetary policy - Adoption of inflation targeting as the strategy of implementing monetary policy

What is the relation between money growth and inflation?

There is strong positive relationship between average rate of inflation and average rate of money growth

What are determinants of inflation?

Expectations Cyclical factors Shocks

How expectations influence inflation?

Inflation expectations affect the wage and price setting pattern This affects actual inflation Low and stable inflation can be maintained if public expectations are firmly anchored It can lead to self-fulfilling expectational equilibria

What central bank needs to be sure about?

Central bank needs to ensure that economy has a nominal anchor

Explain taylor principles

If monetary policy is implemented via interest rate rules, nominal interest rate needs to move more than one-to-one with inflation. But central bank can also control money supply to provide nominal anchor

Does credibility matters?

Credible policy of low inflation anchors inflationary expectations.

What is cyclical problem about?

This problem is related to movements of real output to some benchmark level. Benchmark level of output around which actual output should be stabilized is not constant.

What is the role of central banks concerning cyclical factors?

Central bank needs to monitor cyclical developments and react to them. State of business cycle is of concern as an objective of monetary policy.

What four tips for cyclical factors are there?

- Central bank should avoid too optimistic targets - Cyclical factors have only short-term effects on real economic variables - Not all fluctuations should be stabilized - Stabilization policy of central bank should be defined in terms of gaps (deviations from benchmark)

What are shocks in the market?

Factors that have effects on inflation that are conceptually independent of cyclical factors and expectations

What types of schocks do we recognize?

Cost shocks Supply shocks

What monetary poolicy requires in terms of shocks?

Optimal monetary policy requires that a positive price shock be offset by contractionary monetary policy It calls for central bank to slow down the economy (possibly generate a rise in unemployment).

What are the two approaches to institutionalize a credible low inflation policy?

- Delegating monetary policy to an independent central bank with a mandate to maintain price stability - Delegating monetary policy to another country via: pegged (fixed) exchange rate, currency board or monetary union

What is pegged exchange rate?

It is type of exchange rate regime, where value of currency is matched to the value of another single currency or to a basket of other currencies, or to another measure of value, such as for example gold

What is currency board?

Monetary authority, which is required to maintain an exchange rate with a foreign currency; requires the objectives of a central bank to be subordinated to the exchange rate target

What is monetary union?

Situation where several countries have agreed to share a single currency among them

Political influence and monetary policy.

Political influence over monetary policy leads to excessive inflation and less stable real economic activity. There is negative correlation between average inflation rate and various measures of central bank independence among developed economies.

What is goal independence?

Ability to define its operational goals.

What is Instrument independence?

Independence to conduct policy to achieve stated goals

Examples of bank independance.

New Zealand: government gives numerical targets, Reserve Board can choose price index to calculate exchange rate. USA - congress defines broad goals, FRB translates them into operational ones.

What are the objectives which need to be implemented for creditibility of central bank?

- Policy framework must ensure that the economy has a nominal anchor – price stability is a primary objective of monetary policy - Policy framework should be transparent - Policy framework should contain mechanisms to promote accountability of central bank

What are the components of the monetary policy strategy?

- Objectives - Information structure (put information into a form useful for guiding policy makers) - Operational procedure that determines setting policy instrument

Monetary policy coucil consists of...?

•a Chairperson, this being the President of the NBP, •nine members appointed in equal numbers by the President of the Republic of Poland, the Sejm and the Senate

For how long are members of the council appointed?

For six years.

What is the role of Monetary Policy Council?

- draws up annual monetary policy guidelines - presents the report to the sejm - sets NBP base interest raes - sets ceilings on the liabilities arising from loans - approves the NBP financial plan - accepts the annual accounts of the NBP

What is the basic objective of monetary policy?

Maintaining price stability.

What is the inflation target?

2,5% (+/- 1%)

What is the relation between rates and the market?

Money market rates affect loan and deposit rates at commercial banks and thus the size of loans, the demand within the economy and the inflation rate. The set of monetary policy instruments used by the NBP enables it to determine interest rates on the market

What are the instruments of the monetary policy?

Open market operations Reserve requirements Credit-deposit operations

What are open market operations?

Open market operations are transactions in which the central bank engages with commercial banks on its own initiative.

What does open market operation include?

the conditional and outright sale or purchase of securities or foreign currency, as well as the issue of own-debt securities by the central bank

What is the main function of open market operations?

They balance the demand and supply of funds held by commercial banks at the central bank. This allows the central bank to influence the level of short-term interest rates on the interbank market

Who is conducting open market operations in Poland?

National bank of Poland by issuing own-debt secutities

What is the purpose of reserve requirements?

The purpose of these reserves is to smooth out the impact of movements in banking sector liquidity on interbank interest rates

Where are required reserves held?

On accounts with the NBP. They are set by Monetary Policy Council.

What are credit-deposit operations for?

They are conducted with commercial banks to limit of overnight rates fluctuations; these include the lombard loan and the banks' time deposits at the NBP (overnight deposits). NBP credit-deposit operations affect the level of interest rates on the money market;

What is the ceiling and what is the floor here?

Lombard rate is the ceiling here and the NBP deposit rate is the floor.

NBP offers lombard loans to the bank. What is it for?

to cover short-term liquidity shortfalls

What are the rules of giving lombard loan by NBP?

- collateral consists of Treasury securities and the amount of loan may not exceed 80% of their nominal value -loan matures on the next business day after the date of it being granted -loan is granted upon repayment of a loan granted previously

What time deposits allow commercial banks for?

manage their liquid funds surpluses, preventing short-term interbank market interest rates from falling below the deposit rate

What is the value of NBP base rates?

reference rate 3%, lombard rate 4,5%, deposit rate 1,5%, rediscount rate 3,25%

What is the value of required reserve of NBP?

3,5%