Chapter 13: Financial Policy Chapter 13 Financial Policy Norton Media Library Dwight H. Perkins Steven Radelet David L. Lindauer.

Slides:



Advertisements
Similar presentations
The central bank acts as banker to the commercial banks in a country
Advertisements

MONETARY POLICY IN ISLAMIC FRAMEWORK Ausaf Ahmad Azerbaijan State Economics University Baku April 7-11, 2008.
MONETARY POLICY IN ISLAMIC FRAMEWORK
Money, Banking and the Financial System: An Introduction
Lecture 5 Regulation of money circulation and money supply
The Fed and The Interest Rates
Economics 330 – Money and Banking T and Th from 9:30am to 10:45am Text: Mishkin, Frederic: The Economics of Money, Banking, and Financial Markets, Addison-Wesley,
Measuring GDP and Economic Growth Chapter 1 Instructor: MELTEM INCE
The link between domestic savings, foreign savings, and domestic investment
Open Economy Macroeconomic Policy and Adjustment
Copyright © 2004 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill /Irwin Chapter One Introduction.
© The McGraw-Hill Companies, 2008 Chapter 23 Interest rates and monetary transmission David Begg, Stanley Fischer and Rudiger Dornbusch, Economics, 9th.
Copyright © 2011 Pearson Addison-Wesley. All rights reserved. Chapter 9 Trade and the Balance of Payments.
Monetary Accounts: Analysis and Forecasting Why stress money? Money affects output, inflation, and the balance of payments Money is a medium of exchange.
Macroeconomics (ECON 1211) Lecturer: Mr S. Puran Topic: Central Banking and the Monetary System.
24 FINANCE, SAVING, AND INVESTMENT © 2012 Pearson Addison-Wesley.
Economics - Notes for Teachers
Monetary Accounts: An Overview Why stress money? Money affects output, inflation, and the balance of payments Money is a medium of exchange that greases.
Chapter 5 Policy Makers and the Money Supply © 2011 John Wiley and Sons.
The Fed and Monetary Policy
CHAPTERS 1-4 REVIEW CHAPTER 3 WHAT IS MONEY? SUMMARY
Chapter 1 Why Study Money, Banking, and Financial Markets?
Money, Monetary Policy and Economic Stability
Chapter 1 Why Study Money, Banking, and Financial Markets?
11 Unit 1 Why Study Money, Banking, and Financial Markets?
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill /Irwin Chapter One Introduction.
Monetary Policy.
Money and Banking ( BE 220 ) The Economics of Money, Banking and Financial Markets. By: Frederic S. Mishkin.
Copyright  2011 Pearson Canada Inc Why Study Financial Markets? 1.Financial markets channel funds from savers to investors, thereby promoting economic.
1 International Finance Chapter 15 Money, Interest Rates, and Exchange Rates.
Macroeconomics fifth edition N. Gregory Mankiw PowerPoint ® Slides by Ron Cronovich macro © 2002 Worth Publishers, all rights reserved CHAPTER FOUR Money.
WHAT ARE THE INSTRUMENTS OF MONETARY POLICY? Dr. Ghassan F. Abu Al-soud.
Distinguished Lecture on Economics in Government Exchange rate Regimes: is the Bipolar View Correct? Stanley Fischer Ahmad Bash P13-18.
Chapter 16: The Federal Reserve and Monetary Policy Section 2
Chapter 1 Why Study Money, Banking, and Financial Markets?
GHSGT Review Economics. Unit 1 – Fundamental Concepts of Economics.
7 FINANCE, SAVING, AND INVESTMENT © 2014 Pearson Addison-Wesley After studying this chapter, you will be able to:  Describe the flow of funds in financial.
MONEY AND THE FINANCIAL SYSTEM. OVERVIEW Monetary transmission mechanism Modern financial system Money – kinds, functions, significance Supply of money.
Inflation Samir K Mahajan. SOME DEFINITIONS OF INFLATIONS.
Objectives and Instruments of Macroeconomics Introduction to Macroeconomics.
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 19: Monetary Policy and the Federal Reserve 1.Describe.
Chapter 12 International Linkages Introduction National economies are becoming more closely interrelated Economic influences from abroad have effects.
Why Do Countries Use Capital Controls? Prepared by R. Barry Johnston and Natalia T. Tamirisa - December 1998 Presented by: Alyaa Ezzat.
1 of 32 © 2014 Pearson Education, Inc. CHAPTER OUTLINE 10 - Part 2 The Federal Reserve System Functions of the Federal Reserve Expanded Fed Activities.
Chapter 15 – The Fed and Monetary Policy
Chapter 1 Why Study Money, Banking, and Financial Markets?
1 Role of Central Banking Chapter 4 Part 1 1.Functions of Central bank The need for a central bank Should central bank be independent from government Monetary.
Money, Banking, and Central Banking. Copyright © 2008 Pearson Addison Wesley. All rights reserved Introduction Why is the Federal Reserve System.
26-1 Economics: Theory Through Applications This work is licensed under the Creative Commons Attribution-Noncommercial-Share Alike 3.0 Unported.
Copyright  2011 Pearson Canada Inc Chapter 1 Why Study Money, Banking, and Financial Markets?
Chapter 1 Why Study Money, Banking, and Financial Markets?
Saving, Investment and the Financial System
Chapter 1 Why Study Money, Banking, and Financial Markets?
Copyright © 2010 Pearson Education. All rights reserved. Chapter 1 Why Study Money, Banking, and Financial Markets?
1. What would you do with $5,000? Be specific. 2. What percentage of taxes should the government take? 3. Where is the safest place to keep your money?
1 Chapter one  The federal reserve system The federal reserve system  The business cycle The business cycle  The role of policy The role of policy 
1 Chapter 1 Money, Banking, and Financial Markets --An Overview © Thomson/South-Western 2006.
Why Study Money, Banking, and Financial Markets?
TOPIC 1 INTRODUCTION TO MONEY AND THE FINANCIAL SYSTEM.
Money and Banking Instructor: Dr. Ming-Jang Weng
BSP Control Instruments in Monetary Policy
The Nature of Money Money, Banking and Interest Rates
MONETARY POLICY.
An Introduction to Money and the Financial System
Economics - Notes for Teachers
Saving, Investment, and Capital Flows
© 2016 Pearson Education Ltd. All rights reserved.19-1© 2016 Pearson Education Ltd. All rights reserved.19-1 Chapter 1 Why Study Money, Banking, and Financial.
The Economics of Money, Banking and Financial Markets
Saving, Investment, and Capital Flows
Presentation transcript:

Chapter 13: Financial Policy Chapter 13 Financial Policy Norton Media Library Dwight H. Perkins Steven Radelet David L. Lindauer

Chapter 13 Outline 1.The Function of a Financial System –Money and the Money Supply –Financial Intermediation –Transformation and Distribution of Risk –Stabilization 2.Inflation and Savings Mobilization –Inflation Episodes –Forced Mobilization of Savings –Inflation as a Stimulus to Investment –Inflation and Interest Rates 3.Interest Rates and Saving Decisions 4.Financial Development –Shallow Finance and Deep Finance –Shallow Financial Strategy –Deep Financial Strategy –Panic, Moral Hazard, and Financial Collapse –Informal Credit Markets 5.Monetary Policy and Price Stability –Monetary Policy and Exchange-Rate Regimes –Sources of Inflation –Controlling Inflation through Monetary Policy –Reserve Requirements –Credit Ceilings –Interest-Rate Regulation and Moral Suasion

Financial Policy: Introduction Financial policy deals with all measures intended to affect growth, efficiency and use of diversified financial system to meet it objective. It is also called Monetary Policy There are 4 basic functions of a financial system: 1. medium of exchange, &store of value, 2.Moblize savings from various sources and channel it to investment-financial intermediation. 3. Transfers and distributes risk across the across the economies 4. serves as policy instruments of stabilization

Functions of Financial System 1. Medium of exchange: Money supply Transfer deposits, checking & demand deposits, time deposits, Money Supply: M1= narrow money (C +D) Broad Money M2= includes time deposits (T) Broadest Money=M3 includes liabilites of specialized institutions Summary: M1=C+D, M2= M1 +T, M3 =M2+ O

Concepts of Macro-finance Financial ratio= financial assets/GDP Financial Intermediation: Measure by flow of funds-accounts or liquid/Asset Ratio Risk Transformation and distribution: A perfectly working Financial system will reduce risk with exception of disasters. Stabilization function- to control inflation and recession

Inflation and Saving Mobilization 1. Prevent severe inflation and deflation or hyperinflation such as Zimbabwe. Moderate inflation rate should be within the range of 8 to 12% Inflation episodes (see table 13.2 for history of inflation in various countries) Inflation in major regions of the world including global inflation ( see table 13.1) Case study: Hyper-inflation in Peru:

Saving Mobilization cont. 1. Forced mobilization of savings – reduce money supply: Germany , Peru Inflation as a stimulus to investment. Inflation of about 10% may be OK even helpful 3. Inflation and interest rates: Rate offered to on deposits of savers in a bank- subject to control 4. Real interest rate= nominal rate adjusted for inflation: real rate (r )= (1+i)/(1+P)-1 Example: In Malaysia: i=7% inflation was 5% so the real rate is 7%-5%= 2% (1992)

Financial Development Deep Finance: Promotes growth in the real size of the economic system. Growth of financial system is greater than income growth Shallow Finance : Ratio of liquid assets to GDP grows slowly on not at all or falls

Financial Strategy Shallow Finance Strategy: high reserve requirements on commercial banks, non-price credit rationing, negative interest rate Deep Finance Strategy: Mobilies larger volume of savings for domestic economy, enhance fund accessibility, secure efficient allocation of savings, permit financial process that requires positive real rates solved by rasing nominal rate to curb inflation, Finance, Moral Hazard and Financial collapse: Rapid withdrawal of funds and panic some what like now but classic case of 1995 Pesso Crisis in Mexico, or financial crisis of East Asia in mid 1990s.. Moral Hazard: An effort to protect people and institutions from risky behavior actually leads people to take more risky activities. What is needed is prudential regulation Informal Credits; Many in Africa- Like the money lender See Case of Credit and Saving Inflation: Bangladesh and Indonesia Grameen Bank found by Mohammad Yunus is a classic case. Imposes social descipline

Monetary Policy and Price Stability Monetary Policy Exchange Rate Regimes Fixed, pegged, managed, flexible ( see figure 13.1 for prototypes) Sources of Inflation: Money Supply M=DC +IR= Domestic stock+ Intern. Reserves Change in M= change in DC = change IR Government can only control DC not much control IR

Strategies of Controlling inflation 1. Open market operations: direct control on reserves by central banks 2. Increase legal reserve requirements of bank reserves 3. Increase discount rates so commercial banks can borrow less. 4. Moral suasion: Exhortation of monetary officials 5. Credit ceiling imposed by Central Banl 6. Adjustment in allowable nominal rates on deposits and loans

Chapter13 : Financial Policy Learning Objectives The functions and characteristics of the financial systems in developing countries. The definition of money and liquid assets. The diversity of inflation experience in developing countries and the pros and cons of using inflation as a device to mobilize forced savings. How inflation affects real interest rates and how real interest rates, in turn, affect savings and the demand for liquid assets. The characteristics, causes, and consequences of deep finance versus shallow finance. The character of informal credit markets in developing countries. How management of monetary policy depends on the exchange-rate regime. The causes and consequences of excessive money supply growth. The main tools of monetary policy in developing countries. The causes and consequences of financial panics.

Table 13.1: Broad Money (M2) as a % of GDP

Table 13.3: Inflation in the across the World

Fig. 13.1: Evolution of Exchange Rate Regimes

Chapter 13: Summary CHAPTER OUTLINE I. Financial policy in developing countries encompasses all measures intended to influence the size, structure, and operation of financial markets and the system of financial intermediaries. The financial system plays a key role in development by supplying financial assets (including money, variously de­fined), by mobilizing and allocating savings (financial intermediation), by distributing risk, and by providing monetary authorities with tools for managing economic stability. The ratio of broad money (M2) to GDP is a common measure of financial development. 2 The most obvious problem of financial policy in developing countries has been controlling inflation. The text distinguishes among chronic, acute, and runaway (hyper-) inflation, and then reviews the sad history of high-inflation episodes over the past half century. Usually, the source of inflation can be traced to unmanageable government budget deficits. 3. Some economists argue that moderate inflation can be beneficial, as it forces the mobilization of savings by effectively taxing money balances. Some also contend that inflation may be tolerable as a by-product of keeping aggregate demand buoyant to stimulate investment. Yet, high inflation may have the opposite effects. First, the inflation tax augments domestic savings only if the government has a higher marginal propensity to save than the pri­vate sector, which is improbable. In any case, inflation is a very distortionary form of tax. Second, high inflation often is associated with negative real interest rates. While the link between interest rates and savings is weak, there is no doubt that negative real interest rates strongly affect the form in which savings are held. In particular, negative real interest rates reduce the demand for liquid assets; this impedes monetization and financial intermediation. In addition, negative real interest rates mean that financial institutions must resort to nonprice rationing of funds. Finally, inflation interferes with price signals and adds to investment risks. On balance, high inflation almost certainly has an adverse effect on the level and efficiency of investment.

Chapter 13: Summary cont. 4. Indeed, negative real interest rates is a hallmark of a shallow financial system. Shallow finance results from policies involving repressive interven­tions, which retard development of the financial system. In contrast, deep finance can be achieved by liberalizing financial markets and avoiding sharply negative real interest rates and rapid inflation. A deep finance strategy puts the financial system to work mobilizing and allocating savings. It also accel­erates the development and efficiency of the financial system and helps reduce dependence on informal credit markets. 5. The final section examines the relationship between monetary policy and inflation. From the balance sheet for the banking system, one can derive the fact that money supply growth is determined by the expansion of domestic credit and changes in international reserves: ∆M =∫ ∆DC + ∆IR. This shows that money supply expansion, and thus inflation, is linked to credit expansion for financing government deficits and private investments and to the balance of payments. The second term on the right-hand side of this identity implies that monetary policy is affected by the choice of exchange- rate regime. In a small, open economy with a fixed exchange rate, the monetary authority must buy and sell international reserves to stabilize the foreign exchange market; but this means that it cannot independently control the money supply. Simi­larly, the need to finance large fiscal deficits may cause the central bank to lose control of money supply growth. To the extent that monetary authorities have an independent role in stabilization policy, they influence the volume and cost of credit by determining reserve requirements and the rediscount rate, by managing credit controls, and by using moral suasion to influence the banking system.

End Chapter 13 This concludes the Norton Media Library Slide Set for Chapter 13 W. W. Norton & Company Independent and Employee-Owned Economics of Development SIXTH EDITION By Dwight H. Perkins Steven Radelet David L. Lindauer