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Conduct of Monetary Policy: Tools, Targets and Goals (Monetary Policy …

- - - - OMO
        (buy & sell
        T-bonds/T-bills)
        
        MP tools - set mkt int rate
        
        OMO in treasury securities - highest liquidity; largest trading volume
        
        Able to absorb substantial volume of transactions - w/o excessive price fluctuations
        
        Suitable for fine-tune ST interest & credit availability in financial mkt
        
        Effects
        
        Int rate:
        
        FED purchase securities - addl. demand of securities - increase price, lower yields - int rate declines
        
        Reserve:
        
        purchase - incr reserve - incr ability make loans & create deposits - incr growth of $ & credit supply
        
        Goals
        
        Defensive OMO - preserve status quo & maintain present pattern of int rate & credit availability
        
        Dynamis OMO - upset status quo & change int rate & credit conditions FED believe consistent to goals
        
        Advantages
        
        FED complete control - OMO initiated by FED, volume under control of Board of Governors
        
        Easily reversed - Unanticipated effects easily reversed, if needed
        
        Implemented quickly - one approved, policy implement quickly, avoid administrative delays
      - Discount policy/
        Disc window/
        Disc loan
        
        Facility - bank can borrow reserves from FED
        
        Types
        
        Primary Credit
        Healthy banks permitted to borrow as they wish
        
        Secondary Credit
        Troubled banks experiencing liquidity problems
        
        Seasonal Credit
        Small, regional banks that have seasonal patterns of deposits
        
        Incr
        deposit rate
        
        reduce volume of loans from disc window (cost effect)
        
        borrowing from FED less attractive (subs effect)
        
        FED signal - tighter credit condition (announcement effect)
        a. curtail spending plans
        b. accelerate borrowings 9secure credit needed before int rate move higher
        
        Disadvantage
        
        Negative psychological effect
        
        Direct impact, cannot be used frequently
      - Reserve
        Requirements
        
        FED - bank keep min required reserve
        
        FED policy - incr or decr RR
        
        Changing RR - change MS
        incr RR - bank less money lend - decr MS; VV
        
        Effect of
        Change in RR
        
        Change deposit multiplier
        
        decr RR - incr deposit multiplier
        
        accelerate money growth, deposits, loans
        
        VV
        
        Affect size of money multiplier
        
        CB reduce RR, increase size of money multiplier
        
        Accelerate money growth, deposits, loans
        
        Higher profit, VV
        
        Affect the mix between excess and required legal reserves
        
        Decr RR, portion of RR become excess R
        
        bank convert into loan and investment
        
        expand money supply
        
        Affect interest rate
        
        Lower RR - lower int rate (particularly in money M)
        
        increase amt of borrowings
        
        Advantages
        
        Powerful effect to control MS
        
        Disadvantages
        
        Small changes - large effect on MS
        
        Raising RR - liquidity problems in banks
        
        Frequent change - uncertainty in banks
  - - - Moral Suasion
        
        "arm-twisting" or "jawboning" by CB
        
        encourage banks and other lending institutions to conform with the spirit of its policies
        
        E.g. FED - tighten credit control & slower credit growth, FED issue letter & public statements urge FI to restrain granting loans - slower economic growth, lower price & exchange rate & lower employment growth, VV
      - Margin requirement
        
        use on the purchase and short sales of stocks and convertible bonds
        
        FED prescribe maximum loan value for marginable stocks, convertible stocks and short sales
        
        difference between its market value and max loan value of that security
        
        If FED prescribe higher margin requirement - lower max loan value for marginable stocks, convertible stocks and short sales
        Indirectly CB wish to tighten credit control, slower stock market investment activities