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CFA ECO 4: MONETARY POLICY - Coggle Diagram
CFA ECO 4: MONETARY POLICY
Describe the roles and objectives of central banks
ROLES
Sole supplier of currency
legal tender by law
Fiat currency = money supply on manual control (the central bank is the discipline)
Banker to the government and other banks
Regulator and supervisor of payments system
Lender of last resort
Holder of gold and foreign exchange reserves
Conductor of monetary policy
GOALS
Main goal: control inflation so as to promote price stability
Problem: High inflation leads to menu costs and shoe leather costs
Other goals
Stability in exchange rates with foreign currencies
Full employment
Sustainable positive economic growth
Moderate long-term interest rates
Describe tools used to implement monetary policy tools and the monetary transmission mechanism
Explain the relationships between monetary policy and economic growth, inflation, interest, and exchange rates
The central bank buys securities, which increases bank reserves
many others...
Monetary policy tools
Policy rate
discount rate
repurchase agreement
Policy rate ↓
Interbank rates ↓
Commercial lending rates ↓
Cost of capital ↓
Investment ↑
Reserve requirements
Open market operations.
Sell long-dated government securities
shrinks the money supply and raises rates.
Less Borrowing
Purchase
(long-dated treasuries, mortgage bonds/other securities)
Purchases inject money and lower rates
More Borrowing
Monetary transmission mechanism
def:change in monetary policy, specifically the central bank's policy rate, affects the price level and inflation
Banks' short-term lending rates will increase in line with the increase in the policy rate
Bond prices, equity prices, and asset prices in general will decrease as the discount rates applied to future expected cash flows are increased
Both consumers and businesses may decrease their expenditures because their expectations for future economic growth decrease
The increase in interest rates may attract foreign investment in debt securities
Describe qualities of effective central banks
Contrast their use of inflation, interest rate, and exchange rate targeting in expansionary or contractionary monetary policy
Describe the limitations of monetary policy
monetary tightening may be viewed as too extreme
liquidity trap
zero lower bound (ZLB)
: Rates near zero + no growth = the interest-rate lever has run out of room
For a central bank to succeed in its inflation targeting policies, it should have three essential qualities:
Independence
Credibility
Transparency
Explain the interaction of monetary and fiscal policy
Expansionary fiscal and monetary policy
taken together. Interest rates will usually be lower (due to monetary policy), and the private and public sectors will both expand
Contractionary fiscal and monetary policy
Expansionary fiscal policy and contractionary monetary policy
Contractionary fiscal policy and expansionary monetary policy