reserve norm. Dynamics of the excess reserves ratio (the ratio of balances on correspondent accounts to the deposit base) The amount of excess reserves of the bank formula
Let us suppose that a new depositor writes a check for $100,000 to another depository institution and deposits it in bank /. Bank 1's transaction deposits will immediately increase by $100,000 to $1.1 million. At the same time, Bank 1's total reserves will rise to $200,000. The total transaction deposits of $1.1 million means that required reserves are now $110,000 million. $000, or $90,000. This is reflected in the T-bill (Figure 14-2).
Let's pay attention to excess reserves (fig. 14-2). They were zero before the $100,000 deposit, then rose to $90,000. These assets are not generating income. Bank / will now lend $90,000 to generate income. The volume of lending will increase to $ 990,000. Borrowers will not leave funds on deposit in Bank 1 - they are borrowed to spend. As these funds are spent, actual reserves will eventually decrease to $110,000 (that is, to the amount of required reserves), and excess reserves will again become zero (Figure 14-3).
In this example, the depositor went to Bank 1 and deposited a $100,000 check drawn to another bank. This amount became part of the bank's reserves /. Because this deposit immediately creates excess reserves, Bank 1 was able to keep lending to earn interest. A bank cannot lend more than its excess reserves because it is required by law to keep a certain amount in required reserves.
Consider the T-account of Bank 1 (Figure 14-6). If this balance looks familiar, it's because it's exactly the same as Fig. 14-2. The Fed's bond purchases increased reserves by $100,000 (to $200,000) and also initially increased transaction deposits by $100,000. $10,000), there are $90,000 (i.e. $200,000 - $110,000 = $90,000) excess reserves.
Bank / is not inclined to keep excess reserves that do not earn interest. He will increase his lending by $90,000, as shown in Figure 1. 14-7, exactly repeating Fig. 14-3, but there was no corresponding decrease in lending to any other depository institution.
Recall that in this example, the initial deposit of $100,000 was a check drawn by the bank to the Fed. This amount immediately increased the money supply by $100,000. The process of money creation (in addition to the initial amount) is due to the crushing of reserves in the banking system, plus the tendency of depository institutions to maintain excess reserves at zero levels (assuming sufficient demand for loans).
Bank New deposits Possible loans and investments (excess reserves) Required reserves
Even with a fractional reserve system and zero excess reserves, deposits and the money supply cannot increase without an increase in total reserves. The initial deposit to Bank 1 in the previous example was in the form of a check drawn on the Federal Reserve Bank of the respective county. Therefore, it represented new reserves for the banking system. If the check were drawn, for example, to bank 3, then the total volume of transaction deposits would not change and the money supply would remain the same. Again, checks drawn on other banks are mutually exclusive assets and liabilities. Only by creating excess reserves in the banking system can the money supply increase.
The implications are the same as if, in our example, the depository institutions had used their excess reserves instead of making loans to buy interest-bearing securities. The holders of these securities will receive checks from the depository institution making the purchase and the sellers of the securities then deposit these checks with their depository institutions. The process of expanding deposits will continue in exactly the same way.
We can identify a mathematical relationship between the maximum increase in transaction deposits and the change in reserves. Again, assuming that only transactional deposits exist in the banking system and that bank excess reserves are zero. Consider the following equation, where delta (D) means the change in the variable
In other words, the change in total reserves in the banking system is equal to the product of the required reserve coverage rate and the change in the volume of transaction deposits, provided that up to this point banks did not have excess reserves, that bank customers do not withdraw cash from their accounts, and that there are no other types of deposits in the banking system.
This formula calculates the maximum amount by which the volume of deposits and the money supply can change due to changes in reserves, or the maximum deposit and money multipliers. This formula describes a highly simplified situation in which there are only transaction deposits with a certain required reserve coverage ratio, bank customers do not withdraw cash from their accounts, and bank excess reserves are always zero. In reality, the required reserve coverage rate for various transactional deposits is far from being the same. For example, in April 1992 the required reserve coverage rate for the first $42.2 million in current accounts for all banks was 3% and a 10% rate applied to all deposits above that amount.
In addition, banks may hold excess reserves even if they do not generate interest income. Moreover, when the non-banking sector wants to withdraw a certain amount of cash from bank accounts, the value of the money multiplier will change. We now turn to the consideration of the total money and credit multipliers, which take into account the above factors.
When the seller withdraws the money from the account, the balance of the deposit will decrease to $80,000. Therefore, the total transaction deposits of the bank / after the withdrawal of money from the account will be $1,080,000, as shown on the right side of the T-account (Figure 14-14). In other words, the net increase in bank deposits / will be $80,000 and the ratio of seller's cash to transaction deposits will be $20,000 / $80,000 = 0.25. The seller will reach the expected ratio of cash in his possession and deposits. When the seller withdrew money from the bank account, the bank's total reserves / decreased by the amount of this withdrawal, i.e. $ 20,000, as shown on the left side of the T-account (Figure 14-14). His transaction deposits would now be $1,080,000, his required reserves $108,000 (total transaction deposits times the required reserve ratio, or $1,080,000 X 0.10) and his excess reserves $72,000 (total reserves minus required reserves, or $200,000). - $108,000).
For simplicity, let us assume that banks hold excess reserves in constant proportion to the amount of new transaction deposits. In particular, let this proportion be equal to 5% of all additional transaction deposits. This means that if the current excess reserves are $72,000, then Bank 1 will only hold $4,000 (transactional deposits multiplied by the expected level of excess reserves, or $80,000 X 0.05). This leaves $68,000 of unwanted excess reserves that the bank would like to lend out.
It is clear that the expansion of deposits in our example is much smaller with cash leakage and excess reserves of banks. And this is quite logical. Calculation of the new deposit multiplier Since the expansion of deposits in our example will be smaller, the deposit multiplier will be correspondingly lower. Note that the total reserves of the banking system will change in the amount
The left side of equation (14-7) is the overall change in the government's money supply. The right side of the equation shows that this change depends on the change in the volume of deposits in the banking system, which in turn depends on the required reserve ratio, the level of excess reserves expected by banks, and the ratio of cash to the volume of transactional deposits expected by the non-banking sector.
In the first example, where there was no cash leakage and excess reserves, the deposit multiplier showed how much the money supply would increase as a result of the Fed buying $100,000 in securities. Now, it should be recalled that the money supply, in accordance with the Fed's definition of the monetary aggregate Ml (see Chapter 3), is equal to
Assuming that the required reserve ratio for all deposits was 10%, then the maximum money multiplier would be 10. Cash withdrawals and excess reserves are a serious brake on the expansion of bank deposits. Since 1983, the M1 multiple has increased significantly, and the M2 multiple has been declining since mid-1984. As shown in Chapter 24, if the money
Explain in your own words, without using equations or formulas, why an increase in the excess reserves that banks tend to hold (with other factors held constant) decreases the overall credit multiplier.
A single bank can lend to its customers only on the basis of excess reserves. When that bank has them, it can make loans and change the money supply. If they are not, then the bank cannot do it. Only the banking system as a whole can change the volume of deposits and hence the money supply. This will become apparent as T-a ounts are simplified.
(Graph not provided)Since mid-1999, the average level of bank reserves in the form of balances on correspondent accounts with the Bank of Russia in relation to funds raised, seasonally adjusted, has been steadily at 13-14%.
This indicates, on the one hand, the demand formed by banks for the required amount of free reserves in the current conditions of the functioning of the payment system and risk assessments, and, on the other hand, that the Bank of Russia, through deposit operations, has essentially tied up all the relatively excess bank liquidity without any risk of problems with settlements, while effectively using the interest rate policy for its operations.
The continuing growth of the banking system's reserves, including free reserves, due to the still weak monetary transmission mechanism, predetermined the downward trend in the money multiplier in the first half of 2000 and its barely visible growth in the third quarter.
In 2000, the Bank of Russia set itself the goal of indirectly through its operations to influence the reduction of money market interest rates to a level that would stimulate demand for borrowed resources from the real sector. The monetary policy of the Bank of Russia contributed to a smooth decrease in interest rates, and the availability of free resources in the banking sector, a gradual decrease in credit risks and a general improvement in the economic situation led to a reduction in the 9 months of 2000 in the average weighted rates on loans granted to legal entities by commercial banks for all periods up to a year, from 34 to 20.9%. The margin on transactions with legal entities also decreased (from 21.1% in January to 8.5% in September), but its level is still quite high, as well as lending risks. At the same time, the decrease in the general level of interest rates especially affects the reduction of rates on deposits of individuals, which remained negative in real terms during 9 months of 2000.
Deposits in foreign currency increased in January-September 2000 by 36.9% (in dollar terms). The dynamics of these deposits was unstable. High growth rates of deposits in foreign currency in some months (up to 10%) alternated with an absolute reduction in their size. As a result, the M2X monetary aggregate increased by 40% over 9 months of 2000, which did not exceed the M2 money supply growth rate.
In 2000, the development of the Russian economy was influenced by the favorable situation on the world commodity markets. There was a steady inflow of foreign currency, which exceeded forecast estimates. Conditions were formed that made it possible either to significantly nominally strengthen the ruble, or to forcefully accumulate foreign exchange reserves with the necessary sterilization of free liquidity.
Following the long-term stability of the national currency and taking into account the temporary nature of the factors underlying the improvement in the balance of payments, the Bank of Russia did not seek to strengthen the ruble at an accelerated pace, but used the tactics of accumulating reserves, meaning the accumulation of international liquidity in volumes sufficient to withstand excessive devaluation pressure in the period of a future probable decline in world energy prices and an increase in demand for foreign currency during large payments on external debt.
Preventing a significant strengthening of the ruble, the Bank of Russia, when conducting interventions in the foreign exchange market, chose such a level of the exchange rate that would also allow regulating the growth rate of the money supply, taking into account the growing demand for money. When making decisions, the Bank of Russia took into account the effect of a very wide range of economic factors and trends.
The growth of the money supply in 2000 took place in the context of a slowdown in inflation. The Bank of Russia influenced the money supply to bring it in line with the set inflation target. At the same time, no radical measures were taken to limit the growth rate of the money supply with the aim of necessarily reaching the trajectory of money supply dynamics established at the end of 1999, since the dynamics of a whole range of economic indicators and ongoing calculations of the consequences of such an accelerated growth in the money supply indicated that this process did not contain an immediate inflationary threat. The satisfactory state of public finances, even taking into account the servicing of the country's external debt, did not have an expanding effect on the growth of the money supply, the issued ruble mass was made available mainly to the real sector of the economy. In addition, the high level of the current account surplus, as well as the rather moderate growth in consumer spending, which lagged behind the growth in production, did not indicate excessive demand and, accordingly, the "redundancy" of the money supply.
Banks are able to create new money by lending. Banks create new money when they make loans, and vice versa, the money supply shrinks when customers repay the banks their loans.
Each commercial bank has statutory required reserves, the amount of which is determined by the Central Bank. Required reserves- this is a part of the amount of deposits that each commercial bank must credit to the account of the Central Bank branch. For various deposits (on demand, fixed-term, etc.) their own reserve rate is set - a percentage of the amount of deposits. The minimum size of the reserve fund is set by law (the share of the reserve in the bank's assets ranges from 3 to 20%) and is a tool for regulating the amount of money in the country.
Excess reserves - is the difference between the total reserves of the bank and the required reserves, they are called loan potential of the bank .
The formation of required reserves somewhat limits the ability of commercial banks to provide loans. Excess reserves can be used by the bank to raise money.
For example, a person invested 1000 rubles in a bank. The reserve requirement ratio (rr) is set at 10% for all banks.
The actual reserves (FR) of bank A will amount to 1000 rubles. Therefore, excess reserves are 90% (i.e. E = FR–R). Thus, bank A created 900 rubles. extra money.
FR = R + E,
where R - required reserves;
E - excess reserves.
Bank A's balance sheet will be as follows:
If the acting entity used the received loan of 900 rubles. for the purchase of raw materials, then its suppliers will transfer the money received to their account in bank B, the balance of which will look like this:
|
Deposits+900 |
Thus, bank B created additional money - 810 rubles.
Theoretically, with a reserve ratio of 10%, each ruble invested in the bank will lead to the creation of 10, i.e., there is a multiplication:
m = 1/ rr,
where m is the bank multiplier (money supply multiplier), which shows how many new bank dollars the banking system creates when one additional ruble of deposit enters it.
If R = 10% = 0.1, then m = 1/ 0.1 = 10.
M = m * E,
10 * 900 = 9000 rubles.
This process will continue until the entire amount of the deposit is used as required reserves.
In real life, the multiplier effect of the expansion of bank deposits largely depends on the amount of “leaks” into the system of current circulation, since not all money taken in the form of loans from banks is returned to deposits – some of it continues to circulate as cash. In addition, we do not take into account that bank customers can borrow money from current accounts, which also reduces the ability of banks to issue loans.
The main factors on which the process of creating new money by banks, and, consequently, the change in the money supply, depend are the size of the minimum reserve rate and the demand for new loans from borrowers.
If money were withdrawn from banks' reserves, the multiplier effect would work in the opposite direction. For example, the purchase by commercial banks from the Central Bank of government bonds worth 10 million rubles. reduces the bank's reserve resources by this amount, which ultimately leads to the destruction of bank deposits by 1 million rubles. (with a minimum reserve rate of 10%).
Loan potential of the banking system is equal to the sum of excess reserves of all commercial banks, divided by the required reserve ratio.
The relative increase in the amount of the deposit (deposit) is calculated using the simple interest formula (if the capitalization of the deposit is not provided):
Rd = 1 + i* n,
where Rd - interest (income) on the deposit;
i - annual interest rate on the deposit;
n is the number of years.
If interest is included annually in the amount of the deposit, then the income is calculated according to the compound interest formula:
Rd = (1 + i) n.
Convertibility (convertibility) of the national currency - its free exchange for foreign currencies and vice versa without direct state intervention in the exchange process. Money as an obligatory intermediary serves the development of forms of foreign economic activity, acts in all spheres of international exchange. Through the mechanism of currency convertibility, the problems of an international means of payment, the use of the currency of one state on the territory of other states are solved.
According to the degree of convertibility, the following types of currencies are distinguished:
a) freely convertible (reserve);
b) partially convertible;
c) closed.
Freely convertible currency can be freely exchanged for other foreign currencies. The convertible currency of the most developed countries is called the reserve currency, because. in it, the Central Banks accumulate and store reserves for international settlements and securing their national currency.
Partially convertible currency, as a rule, is exchanged only for some foreign currencies.
closed currency- a national currency that circulates and functions only within its own country and is not exchanged for other foreign currencies.
Purposes of currency restrictions: - Equalization of the balance of payments; - maintaining the exchange rate; - concentration of currency values in the hands of the state.
There are two main areas of currency restrictions: current operations of the balance of payments (trade and non-trade transactions) and financial transactions (movement of capital, loans and other transfers). The degree of convertibility is inversely proportional to the volume and rigidity of the foreign exchange restrictions practiced in the country, which directly lead to a narrowing of the possibilities in the implementation of foreign exchange and payments in international transactions.
8. Mandatory and excess reserves of the bank, their formation and purpose
Each commercial bank has statutory required reserves, the amount of which is determined by the Central Bank. Required reserves- this is a part of the amount of deposits that each commercial bank must credit to the account of the Central Bank branch. For various deposits (on demand, fixed-term, etc.) their own reserve rate is set - a percentage of the amount of deposits. The minimum size of the reserve fund is set by law (the share of the reserve in the bank's assets ranges from 3 to 20%) and is an instrument for regulating the amount of money in the country.
Excess reserves - is the difference between the total reserves of the bank and the required reserves, they are called loan potential of the bank . Loan potential of the banking system is equal to the sum of excess reserves of all commercial banks, divided by the required reserve ratio.
The formation of required reserves somewhat limits the ability of commercial banks to provide loans. Excess reserves can be used by the bank to increase money.
The formation of required reserves is mandatory and includes the total cost of banking services. In some cases, the required reserves are formed from profits. The amount of required reserves is determined using reserve requirements (r) - an indicator that is calculated as a percentage of the amount of required reserves to the total amount of bank deposits. Currently, this indicator ranges from 3 to 15% for different countries and banks.
The following entities are involved in the process of forming the money supply: central bank , commercial banks , contributors - entities whose deposits are kept in banks, borrowers - individuals and organizations that receive loans from banks, as well as organizations that issue bonds that are purchased by banks.
The modern banking system is a partial reserve system. reserves consist of deposits placed by commercial banks with the Central Bank and cash that is physically in the bank. Reserves for banks are assets, and for the Central Bank they are liabilities, since banks can demand payment of them at any time, and the Central Bank is obliged to satisfy this requirement. The total amount of reserves can be broken down into two categories: reserves held by banks at the request of the Central Bank (required reserves ), and additional reserves that banks hold at their own discretion ( excess reserves ) . The amount of required reserves is determined using required reserve ratios (r) - an indicator that is calculated as a percentage of the amount of required reserves to the total amount of bank deposits. Currently, this figure ranges from 3 to 15% for different countries and banks.
The central bank can increase the reserves of the banking system and, accordingly, the money supply in two ways: by providing credit to commercial banks and by buying up government bonds. Both of these operations are active items in the Central Bank's balance sheet, and changing them simultaneously changes the amount of the banking system's reserves.
The lending operations of commercial banks also change the volume of the money supply: it increases when banks make loans and decreases when customers return loans to banks. . In this case, it happens credit (deposit) multiplier - the process of issuing means of payment within the system of commercial banks. Let's consider this process in more detail. Let us assume that the deposits of bank "A" have increased by 1000 den. units In order to be able to give money to the depositor at any time, there is no need to keep the entire amount of deposits in the bank. For this, only the part called required reserves. Let us take for our case a reserve rate equal to 20%, then the amount of a loan that a given commercial bank can issue to a borrower will be determined by the amount excess reserves , which are obtained as the difference between the amount of deposits and the amount of required reserves: 1000-200=800 (cu). Thus, Bank A has increased the money supply by 800, and now it is equal to 800+1000=1800 (CU). Depositors still have deposits of 1,000 units, but borrowers also hold 800 units, i.e., a fractional reserve banking system can increase the money supply.
However, the growth of the money supply does not end there. The one who borrowed money will spend it buying something, and the one who sells it will receive money and deposit it in a commercial bank, let in our example it will be bank "B". With a reserve ratio of 20%, Bank B will keep CU160 in required reserves. (20% of CU800) and the remaining CU640 (these are the excess reserves of Bank B) to be used for issuing loans, increasing the money supply by another 640 units. Bank C, where this money can go in the process of using the loan by the borrower of Bank B, will add another 512 units (excess reserves of Bank C), and so on. This process of money creation will continue until the entire amount of the initial deposit (1000 den. units) will not be used by the banking system as reserves. In our conditional example, the amount of new money will be equal to:
1000 (1+(1–0.2)+(1-0.2)2+(1-0.2)3+…)=1/0.2 x 1000 (5.1)
In general terms, the additional money supply (D MS) resulting from the appearance of a new deposit in the banking system will be equal to:
D MS = 1/r D, (5.2),
where r is the required reserve ratio, D is the initial deposit.
The coefficient 1/r is called banking (deposit) multiplier or the monetary expansion multiplier , which shows how many times the money supply will increase or decrease as a result of an increase or decrease in deposits in the banking system per one monetary unit.
Regardless of whether the bank directs its excess reserves to provide loans or to purchase securities, its role in the process of creating new money (deposits) does not change.
There are two types of bank withdrawals that reduce the ability of the banking system to create money:
1) Leakage of cash, i.e. far from all the money taken in the form of loans from banks is returned back to the banks for deposits, some of it continues to circulate in the form of cash. In addition, bank customers can take cash from current accounts, which also reduces the ability of banks to issue loans.
2) Excess reserves. The larger the amount of required reserves, the lower the total potential of the banking system to expand credit, and, consequently, the amount of new money.
A more general model for changing the money supply is built taking into account the role of the Central Bank, as well as taking into account the possible outflow of part of the money from the deposits of the banking system into cash. Although the Central Bank is able to control monetary base (the sum of cash in circulation and the reserves of commercial banks, in other words, it is money of increased power and is designated as DC), it cannot directly regulate bank reserves, since it is households and firms who decide how much of the DC should exist in the form of cash. In addition, the Central Bank is interested in managing not the reserves as such, but rather the total money supply (M1, M2 and other monetary aggregates). Therefore, it is more appropriate to use the monetary base multiplier or money multiplier (m), which links the monetary base to the monetary aggregate (for example, M1):
m = M1(MS)/MB (5.3),
those. The money multiplier is the ratio of the money supply to the monetary base. It can be represented as the ratio of the amount of "cash-deposits" and the amount of "cash-reserves":
m= C+D/C+R (5.4)
Divide the numerator and denominator of the right side of equation (5.4) by D (deposits) and get:
m=c+1/c+r (5.5),
where c - C / D, r - R / D
The value of "c" - the "cash-deposits" ratio - is determined mainly by the behavior of the population, which decides in what proportion the cash and deposits will be. The value of "r" depends on the required reserve ratio and on the amount of excess reserves that commercial banks intend to keep in excess of the required amount.
Now the money supply can be represented as:
MS =(c + 1 / c + r) MB (5.6)
Thus, the money supply directly depends on the size of the monetary base and the money multiplier. The money multiplier shows how the money supply changes when the monetary base increases by one unit.
An important property of the money multiplier is that it is less than the bank multiplier. This circumstance is due to the fact that when any part of the increase in the monetary base is converted into cash, it will not participate in the process of multiple expansion of deposits, i.e. only part of the increase in the monetary base will participate in this process. The increase in the money supply for a given increase in the monetary base will be less than in the simple model.
The central bank controls the money supply primarily by influencing the monetary base, which in turn has a multiplier effect on the money supply. Thus, the process of changing the volume of money supply can be divided into two stages:
1) Initial modification of the monetary base by changing the obligations of the Central Bank to the population and the banking system (impact on the amount of cash and reserves);
2) The subsequent change in the money supply through the process of multiplication in the system of commercial banks.
The factors that determine the value of the money multiplier and, accordingly, the money supply include the following: reserve requirement and coefficient "c"- the relation "cash-deposits". These indicators and the money supply are inversely related, as well as unborrowed monetary base(the difference between the monetary base and the volume of loans issued by the Central Bank, this is the most controllable part of the monetary base) and refinancing volume. These indicators have a direct impact on the money supply.
An increase in the monetary base, due solely to an increase in cash in circulation, does not initiate the process of deposit multiplication, while its increase due to an increase in reserves servicing deposits generates a multiplier effect.
Instruments of monetary policy. Direct and indirect tools. Operations on the open securities market. Regulation of the accounting (discount) interest rate. Manipulation of the reserve requirement
Monetary policy instruments, they are also methods of the Central Bank's influence on the volume and structure of the money supply, allow changing the monetary base by managing the volume of refinancing and regulating reserve requirements. These include:
1. Lending limits, direct limitation of interest rates - instruments of direct regulation,
2. Operations on the open securities market,
3. Regulation of the accounting (discount) interest rate,
4. Manipulating the required reserve ratio.
Points 2, 3, 4 are instruments of indirect regulation. The efficiency of their use is closely related to the degree of development of the money market. In the transformational economy, both direct and indirect instruments are used, with the former being gradually replaced by the latter in the process of transition to the market. The ultimate goals are implemented by monetary policy, along with fiscal, foreign exchange, foreign trade, structural and other types of government policy. Intermediate and operational goals are directly related to the activities of the Central Bank and are achieved in a market economy with the help of mostly indirect instruments. Let's consider them in more detail.
Open market operations valuable papers are widely used in countries with a developed securities market and difficult in countries where the stock market is at the stage of formation. This tool involves the purchase and sale of government securities by the Central Bank (usually in the secondary markets, since the activity of the Central Bank in the primary markets in many countries is prohibited or restricted by law). Most often these are short-term government bonds or Treasury bills.
When the Central Bank buys securities from a commercial bank, it increases the amount on the reserve account of this bank, accordingly, additional money enters the banking system and the process of multiplicative expansion of the money supply begins. The scale of the expansion will depend on the proportion of the increase in the money supply to cash and deposits: the more money goes into cash, the smaller the scale of monetary expansion. If the Central Bank sells securities, the process is reversed.
Open market operations can be divided into two types: dynamic, aimed at changing the volume of reserves and the monetary base, and protective operations, the purpose of which is to weaken the influence exerted on the monetary base by other factors, for example, a change in the volume of government funds in accounts with the Central Bank and some others. Sometimes operations on the open market are reduced directly to the purchase or sale of securities. But, as a rule, two types of transactions of a different nature are carried out: repurchase agreements (repos), when the central bank buys securities and stipulates that the sellers will buy them back after some time, usually no more than a week. A repo is a temporary purchase operation and is considered the most effective way to carry out those protective operations that are supposed to be reversed in the near future. If the Central Bank seeks to make a temporary sale on the open market, then it resorts to compensating purchase and sale transactions (reverse repos), under which the Central Bank sells securities, stipulating its right to buy them in the near future.
Open market operations have a number of advantages over other monetary policy instruments:
· The Central Bank can fully control the volume of purchase and sale of government securities. Such control is impossible, for example, when lending to banks at a discount rate of interest, when the Central Bank only increases or reduces the attractiveness of refinancing for banks.
· Operations in the open market are flexible and fairly accurate, they can be performed in any volume.
· Operations on the open market are easily reversible: an error made during the operation can be immediately corrected by the Central Bank by conducting a reverse transaction.
· Operations in the open market are carried out quickly. To do this, it is enough to give only instructions to the dealers of the securities market and the trading operation will be carried out.
Regulation of the accounting (discount) interest rate called the discount policy. The discount (discount) rate is the percentage at which the Central Bank issues loans to commercial banks against their bills. The Central Bank can influence the volume of refinancing by influencing the cost of loans (the value of the discount rate). If the discount rate rises, then the volume of borrowings from the Central Bank decreases, and, consequently, the operations of commercial banks to provide loans to business entities also decrease. In addition, banks, getting a more expensive loan, increase their interest rates on loans. The money supply in the economy decreases. Reducing the discount rate works in the opposite direction. Unlike an interbank loan, loans from the Central Bank, falling into the reserve accounts of commercial banks, increase the total reserves of the banking system, expand the monetary base and form the basis for a multiplicative change in the money supply.
The policy of granting loans to banks at a discount rate is called the policy discount window. The central bank can influence the volume of refinancing by influencing the number of loans provided through the management of the discount window. There are three types of loans at a discount rate for banks: corrective (used by banks to solve short-term liquidity problems as a result of a temporary decrease in the volume of deposits), seasonal (provided at certain times of the year to a limited number of banks operating in the agricultural sector), extended (issued to banks experiencing serious liquidity problems). Since the discount rate of interest is lower than the market rate, banks have an incentive to take cheap loans at a discount rate and then use these funds with a higher rate of return. Banks should not profit from refinancing, and the Central Bank sets rules that make it impossible to borrow frequently at the discount rate.
In addition to affecting the monetary base and the money supply, discount policy is very important in preventing banking and financial panics, i.e. it is the most efficient way to provide the banking system with reserves during a banking crisis, as additional reserves go immediately to the banks that need them most. In this sense, the Central Bank performs the function lender of last resort and this is a very important advantage of the discount policy . However, the performance of this function by the Central Bank creates the problem of dishonest behavior of banks and non-banking financial institutions: they take on more risk and possible losses associated with it, knowing that in the event of a problem situation they can always get a loan from the Central Bank. Therefore, the Central Bank should take steps not to become the lender of last resort too often.
The discount policy has a number of shortcomings that do not give reason to recommend it as an effective tool for controlling the money supply. First, fixing the discount rate with changes in the market interest rate can lead to sharp fluctuations spread- the difference between the market interest rate and the discount rate, which leads to unplanned changes in the volume of refinancing and, accordingly, the money supply. And secondly, the discount policy has a weaker effect on the money supply than open market operations, since the volume of refinancing is not fully controlled, like the volume of purchase and sale of government securities. The central bank can change the discount rate, but cannot force banks to apply for loans.
A change in the discount rate is treated as monetary policy indicator. In many developed countries, there is a clear relationship between the discount rate of the Central Bank and the rates of commercial banks. For example, an increase in the discount rate signals the beginning of a restrictive (tight) monetary policy. Following this, the rates on the interbank credit market grow, and then the rates on loans from commercial banks, provided by them to the non-banking sector. Thus, the discount policy has the effect of a signal for business entities about the intentions of the Central Bank.
Manipulation of the reserve requirement.Required reserves- this is part of the amount of deposits that commercial banks must keep in the form of interest-free deposits with the Central Bank. Required reserve ratios are set as a percentage of the volume of deposits. In modern conditions, the required reserves serve to carry out the control and regulatory functions of the Central Bank, as well as for interbank settlements. The higher the required reserve ratio set by the Central Bank, the smaller the share of funds that can be used by commercial banks for active operations. In practice, this tool is used quite rarely, since the procedure itself is cumbersome, and the force of its impact through the multiplier is quite significant and difficult to measure.
The main advantage of the reserve requirement mechanism in exercising control over the money supply is that it affects all banks equally and has a powerful effect on the money supply. However, the strength of this tool is perhaps more of a negative than a positive characteristic, since. small changes in the money supply are difficult to achieve by changes in the reserve requirement. Another disadvantage of using the reserve requirement ratio to control the money supply is that an increase in it can directly lead to liquidity problems for banks that hold small amounts of excess reserves.
In recent years, the Central Banks of many countries around the world have reduced or completely abandoned reserve requirements. Due to the fact that the Central Bank usually does not pay interest on reserve accounts to commercial banks, banks do not earn anything from them and lose the income that they could receive if, for example, they loaned this money. The costs associated with reserve requirements suggest that the cost of raising funds is higher for banks than for other financial intermediaries that are not subject to reserve requirements. For this reason, banks are less competitive, and central banks have lowered reserve requirements in order to increase the competitiveness of commercial banks. However, it does not make sense to completely abandon the reserve requirement, since its existence ensures greater stability of the money multiplier and, consequently, better control over the money supply.
5.4. The transmission mechanism of monetary policy. "cheap money" policy. Politics "dear money"
Transmission Mechanism of Monetary Policy represents the channels of its influence on the organization and functioning of the economy. These channels cover the process from decision-making by the monetary authorities to the specific mechanism of the impact of monetary shocks on the real sector of the economy, taking into account feedback, that is, the reaction of the monetary authorities to changes in the situation in the economy after the implementation of monetary policy measures. The structure of the transmission mechanism consists of chains of macroeconomic variables through which changes in monetary policy are transmitted, and depends on specific conditions, the behavior of economic entities, the structure of the country's financial system, and monetary policy methods. There are theoretical disagreements between Keynesians and monetarists regarding the transmission mechanism of monetary policy.
Keynesian approach: The total demand for money changes inversely with the interest rate. An increase in nominal GDP will shift the demand curve to the right. The money supply is some constant value that does not depend on the interest rate. Monetary policy helps set the rate of interest, but the interest rate itself does not affect the money supply. In this case, it is the real, and not the nominal, interest rate that will influence investment decisions. Here we start from the constancy of prices and assume that the equilibrium interest rate is real (see Figure 5.4).
Rice. 5.4. Money market
The equilibrium interest rate determines the demand curve for investment. At r*, it is profitable for enterprises to invest I* (see Figure 5.4). A change in the interest rate affects the investment component of total spending rather than a change in consumption spending. Investment spending is larger in size and long-term in nature compared to consumer spending, so it is through this channel that interest rates can affect production, employment and price levels.
Rice. 5.5. Demand for investment
Rice. 5.6. Equilibrium GNP
Figure 5.6 presents a simple income-expenditure model of a private closed economy to determine the equilibrium level of GNP (Y*) at which saving equals investment I*.
What monetary policy options can be applied:
· If the equilibrium GNP at Y* is accompanied by unemployment and underutilization of production capacity, then the Central Bank resorts to cheap money policy (credit is cheap and readily available). An increase in the money supply will lead to a decrease in the interest rate, causing a surge in investment and GNP.
If the equilibrium level of GNP (Y*) corresponds to demand-pull inflation, then the Central Bank resorts to expensive money policy , which reduces the availability of credit and increases its costs. A contraction in the money supply will raise interest rates, reducing investment, reducing aggregate spending and limiting demand-pull inflation.
Changes in the values of interest rates, investment and GNP will depend on the specific shape of the curves of demand for money and demand for investment. The steeper the demand curve for money, the stronger will be the impact of changes in the money supply on the interest rate (see Figure 5.4). Each given change in the interest rate will have the stronger effect on the volume of investment and on GNP, the flatter the investment demand curve will be (see Fig. 5.5).
There is a feedback problem that complicates the effectiveness of monetary policy. It must be admitted that the level of GNP can also determine the equilibrium interest rate (movement from Fig. 5.6 to Fig. 5.4). This connection exists because the component of the money demand curve related to the demand for money for transactions depends directly on the level of nominal GNP. GNP growth caused by the cheap money policy in turn increases the demand for money, partially slowing down and blunting the efforts of the cheap money policy to lower interest rates, and vice versa.
Thus, the Keynesian transmission mechanism of monetary policy can be represented as follows:
Change in monetary policy - change in commercial bank reserves - change in money supply - change in interest rate - change in investment - change in nominal GNP.
If the economy does not initially operate at full capacity, changes in investment affect nominal GNP by changing real output through the multiplier effect. If the economy reaches full employment, changes in investment affect nominal GNP through a change in the price level.
According to Keynesians, there are many weak links in the chain of causality, which makes monetary policy an unreliable means of stabilization compared to fiscal policy. It will be ineffective if:
· the demand curve for money is relative to the canopy, and the demand curve for investment is relatively steep (see Figure 5.4, Figure 5.5).
· An unstable shift in the investment demand curve is possible, in which the impact of changes in the interest rate on investment spending will not manifest itself or will weaken (see Figure 5.5).
· If commercial banks do not respond, for example, to the policy of cheap money to issue loans, and the population does not show a desire to take loans.
Monetarist approach to the definition of the transmission mechanism: Monetarists see the money supply as the single most important factor that determines the level of production, employment, and prices. They argue that the expansion of the money supply increases the demand for all types of assets - real and financial, as well as for the current output. Consequently, under conditions of full employment, the prices of all factors will increase. In addition, monetarists consider the velocity of money to be stable, in the sense that it fluctuates little and does not change in response to changes in the money supply itself. This means that changes in the money supply have a predictable effect on the level of nominal GNP.
Monetarists believe that while a change in the money supply (M) may cause short-term changes in real output and employment as the market adjusts to such changes, in the long run a change in M affects the price level. Monetarists consider the economy to be internally stable and tend to produce at full employment. The specific level of this volume depends on such real factors as the quantity and quality of labor, land, capital and technology. It is important to note here that if the volume of production under conditions of full capacity is constant, then changes in M will only lead to changes in prices (P).
