Money and Monetary Policy

Money and Monetary Policy

• In 2008, Lehman Brothers in London went out of business.
• London has become Europe's financial center, surpassing Frankfurt and Paris.
• Gordon Brown's policies attracted people, jobs, and investment to London.
• London trades more international bonds, foreign exchange, and equities than New York.
• In 2007, financial services accounted for 10.1% of the U.K.'s GDP, up from 5.5% in 2001.
• Finance accounts for almost one-fifth of London's total output, more than New York's 15%.
• The U.K.'s FTSE-100 stock index declined about 35% in the past year.
• The British government announced an $88 billion recapitalization package Oct. 8.
• Household debt in Britain rose to 173% of disposable income vs. 106% in 1995.
• Household debt is 139% of income in the U.S.

Function of Money and Money Supply

• Money facilitates specialization, interdependence, and trade.
• The monetary system's efficiency over the barter system defines money's role.
• Money allows for the exchange of goods and services by different individuals.
• Money serves as a vehicle for the free flow of products.
• Money is a common thing of value exchanged for any product in the market.
• Money is the the base of the price system and promotes economic activities.
• Money supply consists of coins, bills, demand deposits in banks, quasi-money, savings deposits, time deposits, and deposit substitutes.

Measures of Money Supply

• Money functions as a medium of exchange; M₁ includes currency circulation plus demand deposits
• M₂ is stock broader definition, includes savings and time deposits or near-money/quasi-money.
  • M₂ = M₁ + time + savings deposits
• M₃, the total liquidator, is M₂ plus debt papers or securities issued by banks (not deposits).
  • M₃ = M₂ + deposit substitutes
• M₄ includes M₃ plus the peso equivalent of residents' dollar deposits in Foreign Currency Deposit Units (FCDU) or Offshore Banking Units (OBU).
  • M₄ = M₃ + peso equivalent of dollar deposits in FCDU's and OBU's

Money Velocity and Income

• Money supply as a medium of exchange multiplies into income.
• The multiplier coefficient relies on the rate of money outflow.
• Money circulation impacting income depends on individual propensity.
• Wealth holders hold money temporarily as idle balances before transactions.
• MV = Y, M = Money Supply, V = Velocity, Y = Nominal Money Income, P = Price, Q = Volume of Goods & Services
• The money supply increases/decreases income due to an increase/decrease in money velocity.
• Institutional factors like paying labor daily can impact money velocity.

Banks and Money Supply

• Banks link investors/borrowers, accept deposits, and are liable to depositors/borrowers.
• Banks create deposit liabilities greater than their reserve via the fractional reserve system.
• Depositors/borrowers circulate demand deposits using checks.
• Banks can lend over actual deposits while sustaining a base reserve.
• Banks can only lend as long as there are available funds.
• Banks create more money by more demand deposits; tightening credit causes the opposite.

Sources of Money Supply

• Lending determines the volume of money checks created; lending more with the fractional cash requirement increases money checks, vice versa.
• The government prints new money to finance operations, increasing currency in circulation and the checks created from currency deposits.
• Foreign currency inflows sold to the Central Bank for pesos increase currency, opposite for outflows; net effect of currency inflows/outflows changes money supply.
• Taxes, being leakages from the circular flow, impact money supply.
• Increased taxes lower money supply, decreased ones rise it.
• There must be a circulation of taxes back to citizens for no leakages through government spending.
• The government borrows from the banking system and increases money in circulation.

Money and the Central Bank

• The Central Bank is responsible for the republic's monetary, banking, and credit system. Goal is to achieve monetary objectives.
• Objectives are to maintain internal and external monetary stability, preserve peso value, and foster monetary and exchange conditions for economic growth.
• The Central Bank regulates funds; any borrowing/lending institution comes under charge of the banks.
• Central Bank is authorized to print money.
• The Central Bank is in charge of proper administration of the monetary, banking, and credit system.
• Sustaining money and belief in the monetary system is essential.
• The Central Bank preserves confidence in money.
• Mismanagement examples include unrestrained money supply leading to inflation.
• Money loses value, which causes people to tie money to assets, which causes less money to produce more assets.
• Pervasive and unchecked circulation and use of fake money destroys the value of real currency.

Monetary Policies - Policy Concepts

• The Central Bank regulates money through the credit/banking system to ensure monetary stability and economic development.
• However, monetary authorities must use instruments to create policy.
• Instruments used must be flexible.
• There might be possible economic impacts due to a change in monetary policy.
• A credit expansion to entrepreneurs would be a long term goal, but a short term tool is used to curb possible inflation.

Short-Run Tools Affecting Money Supply

• Monetary authorities prescribing a base ratio of deposits to control credit.
• An increase in minimum reserve forces banks to limit deposit creation, decreasing base limits causes the contrary.
• For instance, a 0.20 base reserve can allow a bank to lend up to 5x what that deposit can create.
• Rediscounting involves buying banks' loan papers at discounted values to the Central Bank.
• The level of base monetary depends on their reaction and the willing amount of the bank.
• Reserve levels can be raised by widening discount windows, lowering lending rates or increasing them to buy less papers.
• Banks can lend P100,000 at 30% which after 2 years, will get P169,000.
• If the loan paper is sold after a year to get the principle back, the base bank buys that with said interest on the year completed.
• Central banks can buy and sell government stocks with short term maturities (less than a year.)
• Central banks take or lend base monetary from the economy from those securities.
• It pumps more in when it buys back securities like the treasury bills.

Short-Run Tools Affecting Money Supply

• This affects the monetary on how public is willing to buy and sell.
• Public is open to buy and sell and if a central bank can create a net affect on the monetary.
• Central banks can more easily buy and sell those bills through commercial banks for comfort.
• This siphons deposits to the bank from sales of government securities.
• Volume of government securities changes banks reserves which cause greater deposits and monetary.

Selective Control

• Effective range does not need to lead to targets.
• Problems come to life when its not their problem to affect because there is just too much new stuff there.
• Monetary authorities must exercise selective control in order to only cause working problems of the stuff to create the problem, but avoid discriminate issues.
• Example, when the government has been pushing for a banking system to give resources and credits to the rural.
• They had trouble doing so because there was just not enough room there.
• This is when credit was tough of 1966 to 1973 in the United States.
• Commercials rapidly gave higher yields and were maintained in reserve while savings did not.

Policy Coordination

• It is not enough that the instrument is only there to harm so it needs balance. When the instrument can effect and neutralize those backlashes it can solve more.
• For this to kick in, monetary needs too not only increase base and cause them credit.
• Also tight is facilities to take them from opportunity.
• A contractionary monetary means they need taxes so those remain to be there.
• Each should be used where they fit to benefit its self.
• Otherwise it only creates problems.

Historical Context and Crisis Management

• This section details a financial crisis and the measures taken to address it
• The U.S. Treasury aimed to absorb toxic real-estate paper to ease stress on banks and financial markets.
• Regulators tried lowering rates and injecting money into credit markets, but mortgage issues persisted.
• Failed corporations were frequent: Bear Stearns, Merrill Lynch, and AIG had fallen
• Investors fled to safety, even in money market funds, and yields to short-term Treasury bonds fell
• Central banks intervened with $247 billion in funding, including the Fed, ECB, and Bank of Japan.
• The U.S. SEC banned short-selling of stock
• Yields to short-term bonds fell, with lenders willing to accept no losses to be guaranteed a "return" of initial deposit
• RTC-like mechanisms worked to solve crises
• Economists refer to this as a ‘once-in-a-century' event