Transcript Money Market

The Money Market &
Monetary Policy
Demand for Money
• Transactions demand for money to pay for
current transactions. Related mostly to the
level of income.
• Asset demand for money to finance
unanticipated transactions (precautionary)
and to finance speculative purchases
(speculative)
Interest rate
Demand for Money
An inverse relationship between
the interest rate and the
quantity of money that
people are willing to
hold at any given
interest rate.
MD
Money
Fig 16.4
Why does the Demand for
Money curve Slope
Downwards
• As interest rates increase, the opportunity
cost of holding money in non or low
interest bearing forms increases. The
incentive of not holding money increases
or the incentive of holding money
decreases.
Supply of Money
Interest rate
• At a point in time, the supply of money is
fixed. It is not related to the interest rate.
Ms
Money
Interest rate
Money Market
r
Ms
Market equilibrium interest
rate (r) occurs where
quantity demand for money
equals quantity supplied.
At interest rate above r, Ms
> Md. Market forces drive
interest rates lower.
At interest rate below r, Ms
< Md. Market forces drive
interest rates higher.
Md
Money
r’
Interest rate
Demand conditions change
Ms
Incomes increase. Price level
increases Transactions demand
for money increases.
Interest rates increase.
r
Md’
Md
Money
Supply conditions change
• Money supply is controlled by the RBNZ.
• Money supply is controlled through
changes in the OCR and through OMO
and through “Moral Suasion”.
NZ Monetary Policy
Reserve Bank Act 1989
• The administration of monetary policy was
passed from the Minister of Finance to the
Reserve Bank.
• The objectives of monetary policy were
reduced to the single goal of obtaining and
maintaining stability in the general level of
prices.
NZ Monetary Policy
• Policy Target Agreement (PTA) defines
price stability. The % is negotiated
between the Government and the RBNZ.
• PTA defines price stability as annual
increases in the CPI of between 1% and
3% on average over the medium term.
Official Cash Rate
• The Official Cash Rate (OCR) is an
interest rate set by the Reserve Bank to
implement monetary policy, so as to
maintain price stability.
• By setting the OCR, the RBNZ is able to
influence short term interest rates such as
the 90 day bill rate
Official Cash Rate
• When an OCR is announced - it is a
percentage number - the Reserve Bank
undertakes to pay financial institutions an
interest rate 0.25 per cent below the OCR
for money deposited in Reserve Bank
settlement accounts. The Reserve Bank
also undertakes to provide overnight cash
to banks, charging interest at 0.25 per cent
above the OCR.
Official Cash Rate
• The effect of this is that no commercial
bank is likely to offer short-term loans at a
rate significantly higher than the Official
Cash Rate. That's because other banks
would undercut that, using credit from the
Reserve Bank.
Open Market Operations
• The purpose of the Bank's liquidity
management operations, which comprises
the daily Open Market Operation (OMO),
FX swaps and Bond repurchase window,
is to offset the big day-to-day fluctuations
in government spending and revenue. The
Bank currently targets a daily settlement
cash level of $20 million through its OMO.
Open Market Operations
• The Bank prepares and maintains
forecasts on the influences to settlement
cash and uses these to determine how
much cash to inject or withdraw on any
given day. These forecasts are prepared
some months ahead and are then updated
on an ongoing basis, as more information
comes to hand.
Moral Suasion
• The RBNZ instructs the financial markets
what it would like the markets to do.
Financial markets usually respond to such
‘suasion’.
• These instructions can be expressed in
periodic press releases or in released
MPS (monetary policy statements).
Lowering
OCR
Interest
rate
Interest
rate
RBNZ OCR Changes
MS1 MS2
MD
Money
Raising
OCR
MS2 MS1
MD
Money
Fig 16.6 & 16.7
Loose Monetary Policy
Decrease in OCR
Decrease in OCR
Bank reserves decrease
Interest rates decrease
Supply of money increases
I
Higher Aggregate Demand
C
Increase in real GDP
ER
X
M
Tight Monetary Policy
Increase in OCR
Increase in OCR
Bank reserves increase
Interest rates increase
Supply of money decreases
I
Lower Aggregate demand
Reduced inflationary pressure
Decrease in real GDP
C
ER
X
M
Open Market Operations
Open Market Operations
The buying and selling of
bonds by the central bank.
To increase the
money supply, the
central bank buys
bonds.
To decrease the
money supply, the
central bank sells
bonds.
RBNZ OMO Changes
Selling Bonds
Interest
rate
Interest
rate
Buying back bonds
MS1 MS2
MD
Money
MS2 MS1
MD
Money
Fig 16.6 & 16.7
The Business Cycle & Monetary
Policy
In times of economic growth,
inflationary pressures are
usually high. Capacity is tight,
resources are fully employed,
the output gap is small and
there is pressure for the price
level to rise.
The RBNZ employs a tight
monetary policy increasing
the OCR regularly. This tends
to reduce inflationary
pressures.
%GDP
change
Economic
boom
Time
The Business Cycle & Monetary
Policy
In times of economic
recession, inflationary
pressures are usually low.
There is excess capacity,
resources are unemployed,
the output gap is high and
real GDP is decreasing.
The RBNZ employs a loose
monetary policy decreasing
the OCR regularly. This tends
to boost spending and real
GDP.
%GDP
change
Economic
Recession
Time