1. Monetary Policy and Central Banking
EC 344

2. Monetary Policy and Central Banking
The aim of monetary policy
What are the tools
Monetary Policy in action:FED and CBRT

3. Aims of central banks Past and now Dual or single mandate,
FED Dual Mandate: growth and inflation
CBRT: controlling price stability.

4. Financial Markets Money Markets Required Reserves
Transactions with Central Bank
TRLIBOR/ SWAP
Yield Curves

5. FED Open Market Committee
7 members decide on FED funds rate,
Meets every 6 weeks (8 time a year)
Decides on tightening or easing,
Very rarely they make a decision in between two meetings (an exception through the recent crisis)

6. CB’s Targets Inflation targeting. Explicit or implicit target,
Explicit target: CPI or Core inflation
CBRT: CPI targeting.

7. Central Bank’s Independence
Independence of Central Banks
Politicians are pro-growth does not want unemployment close to elections.
Inflation is a medium term problem so politicians can live with this future risk.
So there is always a conflict between politicians and central banks
Since inflation was a common enemy for most economists CB’s independence is (or was) very desirable.

8. Monetary Policiy Tools
Reserve Requirements
FED funds rate
Discount rate

9. Monetary Tools
FED funds rate:

10. CB’s Balance Sheet
Assets: Treasuries, Agencies, MBS, other
Liability: Currency in circulation, Reserves, Repos other

11. Orthodox versus non-orthodox CB policies: Quantitative Easing
FED normally uses OMO and FED funds rate to implement contractor or expansionary policies.
Usually CB’S use bills and short term bonds as collateral for REPO’s.
However, when a very large monetary expansion is necessary more flexible monetary rules are used.
Rather than buying conventional banks’ asset, FED bought Mortgage Backed Securities, corporate bonds etc.

13. US Credit Crisis and FED’s Response
Decreasing house prices,
Loss of confidence on financial assets written on house prices
decreasing collateral values of MBS etc
Increasing the need for liquidity
Illiquid and levered investment banks go bankrupt.
Financial system was about to collapse so FED came to rescue.

14. Decrease in US House Prices:

15. Loss on the value of collaterals and increase in hair cuts

16. Lehman Brothers before default
1% of liquidity
3% of equity/assets:
leverage 33

17. Liquidity Dries

18. Bankruptcy of Investment Banks

19. FED’s Balance Sheet: 4.5 trillion USD now!

20. FED Funds Rate

21. US Yield Curves: Before the Crisis Now (2007 Dec and 2017 November) 200 bps down

23. Effective FED Funds rate and FED target: Spread target-effective=12 bps average max 133 after Lehman

24. All CB’s were expansionary Japan, ECB FED)

25. FED’s discount window: who used?

26. FED balance sheet liability

28. 2007
Total Balance Sheet,
Jan. 2007: $859 billion Liabilities: Currency: $820 billion Reserves: $12 billion 
Assets: T bills: $277 billion T bonds: $502 billion

29. March 2013 Total Balance Sheet
total: $3,084 billion
Liabilities: Currency: $1,173 billion Reserves: $1,748 billion
Assets: T Bills: $0 T Bonds: $1,756 billion Mortgage-Backed Securities: $1,015 billion Agency Debt: $74 billion

32. FED’s Balance Sheet

33. Turkish Central Bank

34. Money Markets
This is the market in which banks borrow or lend in order to satisfy their short term (less than one year) financial needs. Main purpose is to use excess TL, or finance TL deficit. On top of that, another purpose is to speculate on interest rate expectations and generate profit.
CBRT TL Deposit Market Transactions:
CBRT is the “lender of last resort”.
Banks place their excess liquidity to CBRT, or borrow from CBRT until 4 pm. Banks, also, can transact with CBRT between 4 pm and 5 pm using late liquidity rates
Late Liquidity
TCMB O/N Borrowing Rate

35. Repo market ISE Repo and Inverse Repo Market
Banks and other financial intermediaries can transact until 2:00 pm.
İşlem yapılan vadeler

36. Funding of CBRT
-20.00
-15.00
-10.00
-5.00 -
5.00
10.00
15.00
20.00
25.00
Milyar TL
Funding of CBRT
Pulled of with Interbank
Pulled off with REPO
Net Funding

37. CBRT funding: 2017, 120-130 billion TL daily

38. Turkish Inflation Targeting Performance

40. İnflation composition and internal demand
CPI Index Turkey: 42% of the CPI Basket is based on foreign exchange rate

41. How can TL interest rates can help CPI increase?

42. Inflation Targeting Performance:CBRT
year
target
realization
deviation
2002 35
29.7
-15
2003 20
18.4 -8
2004 12
9.3
-23
2005 8
7.7 -4
2006 5
9.7 94
2007 4
8.4
110
2008
10.1
153
2009
7.5
6.5
-13
2010
6.4 -2
2011
5.5
10.4 89
2012
6.2 24
2013
7.4 48
2014
8.2 64
2015
8.8 76
2016
8.5 70
2017
140

43. Which regime was more successful?

44. What are costs of fighting with inflation?

45. Decreasing real interest rates and real exchange rates (Real Effective Exchange Rate)

46. Side effects of high real interest