9' Money and Monetary Policy

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9. Money and Monetary Policy
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The Meaning andFunctions of Money

• The functions of money
• medium of exchange
• means of storing wealth
• means of evaluation
• means of establishing value of future claims and
  payments
• What should count as money?
• narrow definitions of money
• broad definitions of money

3
Financial System in the UK

• The key role of banks
• deposits and loans
• liabilities and assets
• retail and wholesale deposits and loans
• Liabilities
• sight deposits

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Balance sheet of UK banks March 2000
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Financial System in the UK

• The key role of banks
• deposits and loans
• liabilities and assets
• retail and wholesale deposits and loans
• Liabilities
• sight deposits
• time deposits

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Balance sheet of UK banks March 2000
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Financial System in the UK

• The key role of banks
• deposits and loans
• liabilities and assets
• retail and wholesale deposits and loans
• Liabilities
• sight deposits
• time deposits
• certificates of deposit

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Balance sheet of UK banks March 2000
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Financial System in the UK

• The key role of banks
• deposits and loans
• liabilities and assets
• retail and wholesale deposits and loans
• Liabilities
• sight deposits
• time deposits
• certificates of deposit
• repos

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Balance sheet of UK banks March 2000
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Balance sheet of UK banks March 2000
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Financial System in the UK

• Assets
• cash and balances with the Bank of England

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Balance sheet of UK banks March 2000
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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans

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Balance sheet of UK banks March 2000
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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans
• longer-term loans

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Balance sheet of UK banks March 2000
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Balance sheet of UK banks March 2000
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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans
• longer-term loans
• Liquidity and profitability

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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans
• longer-term loans
• Liquidity and profitability
• profitability

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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans
• longer-term loans
• Liquidity and profitability
• profitability
• liquidity

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Financial System in the UK

• Assets
• cash and balances with the Bank of England
• short-term loans
• longer-term loans
• Liquidity and profitability
• profitability
• liquidity
• the liquidity ratio

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Balance sheet of UK banks March 2000
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Financial System in the UK

• The Bank of England
• note issue
• management of government's borrowing programme
• provides liquidity to the banks
• operates monetary and exchange rate policy

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Financial System in the UK

• The London money market
• the discount and repo markets
• discounting
• the repo market
• last-resort facilities by Bank of England
• the parallel money markets

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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK

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UK monetary aggregates (end April 2000)
million
Cash outside Bank of England Banks
operational deposits with Bank of England M0
30 523 214 30 737
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UK monetary aggregates (end April 2000)
million
Cash outside Bank of England Banks
operational deposits with Bank of England M0
Cash outside banks (in circulation)
Private-sector retail bank and building society
deposits M2
30 523 214 30 737 25 964 537 397 563 361
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UK monetary aggregates (end April 2000)
million
Cash outside Bank of England Banks
operational deposits with Bank of England M0
Cash outside banks (in circulation)
Private-sector retail bank and building society
deposits M2 Private-sector wholesale bank and
b.s. deposits CDs M4
30 523 214 30 737 25 964 537 397 563 361 270
349 833 710
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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit

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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit
• simple illustration

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Credit creation Banks' original balance sheet
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Credit creation Effect of a new deposit of
10bn
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Credit creation Full effect of a new deposit of
10bn
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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit
• simple illustration
• the bank multiplier

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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit
• simple illustration
• the bank multiplier
• 1/L

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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit
• simple illustration
• the bank multiplier
• 1/L
• the real world

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The Supply of Money

• Definitions of the money supply
• monetary base
• broad money
• Definitions in the UK
• The creation of credit
• simple illustration
• the bank multiplier
• 1/L
• the real world
• no precise bank multiplier

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The Supply of Money

• Causes of increases in money supply
• banks reduce liquidity ratio
• inflow of funds from abroad
• PSNCR and its financing
• Money supply exogenous or endogenous?
• Relationship between money supply and the rate of
  interest

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The supply of money curve (a) exogenous money
supply
Rate of interest
O
Quantity of money
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The supply of money curve (b) endogenous money
supply
Rate of interest
O
Quantity of money
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The Demand for Money

• The motives for holding money
• transactions motive
• precautionary motive
• speculative motive
• Demand for money and interest rates
• active balances
• idle balances
• the liquidity preference curve L

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The demand for money (liquidity preference) curve
Rate of interest
O
Money
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Monetary Equilibrium

• Equilibrium in the money market
• equilibrium interest rate where D and S of money
  are equal

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Equilibrium in the money market
Rate of interest
re
O
Me
Money
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Monetary Equilibrium

• Equilibrium in the money market
• equilibrium interest rate where D and S of money
  are equal
• Equilibrium in the foreign exchange market

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Monetary Equilibrium

• Equilibrium in the money market
• equilibrium interest rate where D and S of money
  are equal
• Equilibrium in the foreign exchange market
• increased money supply leads to lower interest
  rates

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Monetary Equilibrium

• Equilibrium in the money market
• equilibrium interest rate where D and S of money
  are equal
• Equilibrium in the foreign exchange market
• increased money supply leads to lower interest
  rates
• lower interest rates lead to a lower exchange rate

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Monetary Equilibrium

• Effects of changes in money supply on national
  income
• effect on interest rates

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The demand for and supply of money
Rate of interest
O
Money
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The demand for and supply of money
MS
Rate of interest
r1
L
O
Q1
Money
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Monetary Equilibrium

• Effects of changes in money supply on national
  income
• effect on interest rates
• effects of changes in interest rates on investment

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Monetary Equilibrium

• Effects of changes in money supply on national
  income
• effect on interest rates
• effects of changes in interest rates on
  investment
• effects of changes in interest rates on the
  exchange rate, and hence imports exports

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Monetary Equilibrium

• Effects of changes in money supply on national
  income
• effect on interest rates
• effects of changes in interest rates on
  investment
• effects of changes in interest rates on the
  exchange rate, and hence imports exports
• effects of changes in investment, imports and
  exports on national income

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Monetary Policy

• Approaches to monetary policy
• discretionary policy
• rules-based policy
• money supply rules
• inflation targets
• Control of money supply over medium and long term
• restricting size of PSNCR
• problem of financial crowding out

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Monetary Policy

• Short-term monetary control
• techniques to control money supply
• open-market operations
• other
• controlling interest rates
• role of Monetary Policy Committee
• backing up MPC decisions by Bank of England
  actions in repo market
• rationing credit

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Effectiveness of Monetary Policy

• Reducing the PSNCR
• the desire to cut taxes
• difficulty in cutting government expenditure
• Short-term monetary control
• problems with credit rationing
• effectiveness of changes in interest rates
• inelastic demand for loans
• unstable demand for money
• importance of confidence in policy