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MONETARY
POLICY
What is monetary policy?
“…the process by which the
monetary authority of a
country controls the
supply of money.”
What for?
What for?
Expansionary
Increases the total
supply of money in
the economy more
rapidly than usual
Expands the money supply more slowly than usual or even shrinks it.
Contractionary
Problem
• unemployment and deflation
Remedy
• induce an expansion in the supply of money, and therefore spending, by reducing the interest rate
Means
• Buy bonds in the open market
Problem
• inflation
Remedy
• induce a contraction in the supply of money, and therefore spending, by increasing the interest rate
Means
• Sell bonds in the open market
Open Market Operations
The buying and selling of government securities by the Reserve Bank on secondary
markets
OMOs aim to…
manipulate the short term interest rate
manipulate the supply of base money
control the total money supply
How OMOs Work: Buying securities from commercial bank
• Gives up securitiesBank
• Pays the bank
Fed/ CB • Increas
es reserves Bank
How OMOs Work: Buying securities from public
• Gives up securitiesPublic
• Pays
Fed/ CB • Deposit
s in bank
Public
• Increases reserves
Bank
How OMOs Work: Selling securities to commercial bank
• Gives up securities
Fed/CB
• Pays
Bank • Decreases reserves
Bank
How OMOs Work: Selling securities to public
• Gives up securities
Fed/CB
• Pays by check from bank
Public • Decreases reserves
Bank
Understanding The Reserve Requirements
Required reservesA certain fraction of deposits that a depository institution is required to reserve.
Set by the central bank
Affects the size of loan that the bank can offer
Required Reserve and Monetary Policy
Required Reserve and Monetary Policy
Other tool: Discount Rate
The interest rate charged by Federal Reserve Banks to depository institutions on short-term loans.
Discount Rate in Indonesia
Goals of Monetary Policy
Stability in
foreign
exchange
market
Price stability High
employment
Economic growth
Financial markets stabilityInterest rate
stability
Nominal Anchor in Price Stability Goal
Nominal anchor uses a certain nominal variable which ties down the price level.
For example: maintaining an inflation rate between 2% - 4 % might be an anchor.
Time-Inconsistency Problem
This problem arises because policy makers are always tempted to pursue monetary policy that is more expansionary because it would boost economic output.
High Employment
“…does not mean that unemployment is at
zero”
Economic Growth
“…ensuring that resources are not idle”
Stability of Financial Markets
“…crises can interfere with
the main function”
Interest-Rate Stability
“…fluctuations can create
uncertainty in economy”
Stability in Foreign Exchange Market
“…stability makes it easier for businesses to plan ahead”
THANK YOU.
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