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Monetary Policy Target bank Liquidity (S of credit) (Bank Liquidity…
Monetary Policy
Target bank Liquidity
(S of credit)
Bank Liquidity
refers to cash reserve maintained by banks to back up loans created
fraction of total amount of loans extended
ensures ability to honour withdrawals made by depositors
lower cash reserve ratio, greater ability to provide loans
Measures to Control Bank Liquidity
Open Market Operations
Central Bank sells/buys back treasury bills or short-term gov. bonds
buyers pay with cheques drawn on commercial banks or deposit cheques received into commercial banks
:arrow_down:/:arrow_up: cash holdings of commercial banks and hence their credit-creating ability and money supply in economy
Bank's Cash or Liquidity Ratio
gov. can impose statutory minimum reserve requirements
lower for expansionary policy
Special Deposits
Central Bank can require banks to place with it a % of their deposits in a special account
Special deposits are frozen
cannot be withdrawn until authorities release them
simple and direct way of reducing bank's liquidity
Limitations
No impact on demand for credit
bad times, pessimism, banks willing to lend but no borrowers
good times, strong D for credit, banks can find ways to circumvent liquidity restrictions to provide loans
eg. arrange for customers to borrow from overseas branches that are outside the jurisdiction of Central Bank
Influx of short term capital
(hot money)
curtail bank credit by :arrow_up:interest rate to rate higher than that of other countries
-> foreigners may invest funds in domestic banks to earn higher return
Quantitative Easing
Print money to pay for bonds purchased by Central Bank, to inject more cash to boost liquidity
Unconventional since potentially highly inflationary
QE over
Interest Rate
global financial crisis: interest rate near zero, cannot lower further
commercial banks also unable and unwilling to lend due to bad debts incurred
sell bonds, no need to get loans from banks
some of the injected cash finds its way into banking system as cash deposits, puts banks in better position to provide loans
Effectiveness & Implications
improves market confidence
highly inflationary in future
massive capital outflow
massive cash injection and very low interest rate
-> invest in places with higher return
-> asset bubbles in other countries
hence reduces inflation