1. Money and Monetary Policy

2. Meaning and Functions of Money The functions of money –medium of exchange –means of storing wealth –means of evaluation –means of establishing value of future claims and payments What should count as money? –narrow definitions of money –broad definitions of money

3. Financial System in the UK The key role of banks –deposits and loans –liabilities and assets –retail and wholesale deposits and loans Liabilities –sight deposits

4. Balance sheet of UK banks: February 2003

6. Financial System in the UK The key role of banks –deposits and loans –liabilities and assets –retail and wholesale deposits and loans Liabilities –sight deposits –time deposits

7. Balance sheet of UK banks: February 2003

8. Financial System in the UK The key role of banks –deposits and loans –liabilities and assets –retail and wholesale deposits and loans Liabilities –sight deposits –time deposits –certificates of deposit

9. Balance sheet of UK banks: February 2003

10. Financial System in the UK The key role of banks –deposits and loans –liabilities and assets –retail and wholesale deposits and loans Liabilities –sight deposits –time deposits –certificates of deposit –repos

11. Balance sheet of UK banks: February 2003

15. Financial System in the UK Assets –cash and balances with the Bank of England

16. Balance sheet of UK banks: February 2003

18. Financial System in the UK Assets –cash and balances with the Bank of England –short-term loans

19. Balance sheet of UK banks: February 2003

22. Financial System in the UK Assets –cash and balances with the Bank of England –short-term loans –longer-term loans

23. Balance sheet of UK banks: February 2003

28. Financial System in the UK Liquidity and profitability –profitability –liquidity the liquidity ratio

29. Balance sheet of UK banks: February 2003

30. Financial System in the UK The central bank –Bank of England, ECB, Fed, etc. –functions note issue acts as a bank –to the government –to overseas central banks overseas activities of banks provides liquidity to the banks –lender of last resort operates monetary and exchange rate policy

31. Financial System in the UK The London money market –the discount and repo markets discounting the repo market last-resort facilities by Bank of England –the parallel money markets the inter-bank market inter-companies deposit market market for certificates of deposit, etc. foreign currencies market

32. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK –definitions in the UK: M0, M4

33. UK monetary aggregates: (end February 2003) Cash outside Bank of England + Banks’ operational deposits with Bank of England = M0 Cash outside banks (in circulation) + Private-sector retail bank and building society deposits = Retail deposits and cash in M4 (also known as M2) + Private-sector wholesale bank and b.s. deposits + CDs = M4 36 861 91 36 952 30 630 676 969 707 599 295 996 1 003 595 £ million

34. UK monetary aggregates: (end February 2003) Cash outside Bank of England + Banks’ operational deposits with Bank of England = M0 Cash outside banks (in circulation) + Private-sector retail bank and building society deposits = Retail deposits and cash in M4 (also known as M2) + Private-sector wholesale bank and b.s. deposits + CDs = M4 36 861 91 36 952 30 630 676 969 707 599 295 996 1 003 595 £ million

35. UK monetary aggregates: (end February 2003) Cash outside Bank of England + Banks’ operational deposits with Bank of England = M0 Cash outside banks (in circulation) + Private-sector retail bank and building society deposits = Retail deposits and cash in M4 (also known as M2) + Private-sector wholesale bank and b.s. deposits + CDs = M4 36 861 91 36 952 30 630 676 969 707 599 295 996 1 003 595 £ million

36. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK –definitions in the UK: M0, M4 –euro zone definitions: M1, M2, M3

37. UK monetary supply using ECB measures: (end February 2003) UK monetary supply using ECB measures: (end February 2003) Currency in circulation + Overnight deposits = M1 + Deposits with agreed maturity up to 2 years + Deposits redeemable up to 3 months' notice = M2 + Repos + Money market funds and paper = M3 31 351 513 292 544 643 81 696 296 518 922 857 88 978 57 496 1 069 331 £ million

38. UK monetary supply using ECB measures: (end February 2003) UK monetary supply using ECB measures: (end February 2003) Currency in circulation + Overnight deposits = M1 + Deposits with agreed maturity up to 2 years + Deposits redeemable up to 3 months' notice = M2 + Repos + Money market funds and paper = M3 31 351 513 292 544 643 81 696 296 518 922 857 88 978 57 496 1 069 331 £ million

39. UK monetary supply using ECB measures: (end February 2003) UK monetary supply using ECB measures: (end February 2003) Currency in circulation + Overnight deposits = M1 + Deposits with agreed maturity up to 2 years + Deposits redeemable up to 3 months' notice = M2 + Repos + Money market funds and paper = M3 31 351 513 292 544 643 81 696 296 518 922 857 88 978 57 496 1 069 331 £ million

40. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit

41. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit –simple illustration

42. Credit creation: Banks' original balance sheet

43. Credit creation: Effect of a new deposit of £10bn

44. Credit creation: Full effect of a new deposit of £10bn

45. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit –simple illustration –the bank multiplier

46. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit –simple illustration –the bank multiplier 1/L

47. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit –simple illustration –the bank multiplier 1/L –the real world

48. The Supply of Money Definitions of the money supply –monetary base –broad money Definitions in the UK The creation of credit –simple illustration –the bank multiplier 1/L –the real world no precise bank multiplier

49. The Supply of Money Causes of increases in money supply –banks reduce liquidity ratio –inflow of funds from abroad –PSNCR and its financing Money supply: exogenous or endogenous? –Relationship between money supply and the rate of interest

50. The supply of money curve: (a) exogenous money supply O Rate of interest Quantity of money MSMS

51. The supply of money curve: (b) endogenous money supply O Rate of interest Quantity of money MSMS

52. The Demand for Money The motives for holding money –transactions and precautionary motive –assets or speculative motive –the total demand for money Determinants of demand for money –money national income –frequency with which people are paid –financial innovations –speculation about future return on assets –rate of interest

53. The demand for money (liquidity preference) curve O Rate of interest MdMd Money

54. Monetary Equilibrium Equilibrium in the money market –equilibrium interest rate where D and S of money are equal

55. Equilibrium in the money market O Rate of interest MdMd Money MSMS rere MeMe

56. Monetary Equilibrium Equilibrium in the money market –equilibrium interest rate where D and S of money are equal Equilibrium in the foreign exchange market

57. Monetary Equilibrium Equilibrium in the money market –equilibrium interest rate where D and S of money are equal Equilibrium in the foreign exchange market –increased money supply leads to lower interest rates

58. Monetary Equilibrium Equilibrium in the money market –equilibrium interest rate where D and S of money are equal Equilibrium in the foreign exchange market –increased money supply leads to lower interest rates –lower interest rates lead to a lower exchange rate

59. Monetary Equilibrium Effects of changes in money supply on national income –effect on interest rates Ms   r 

60. The demand for and supply of money O Money Rate of interest MSMS MdMd r1r1 Q1Q1

61. O Money Rate of interest MdMd r1r1 Q1Q1 r2r2 Q2Q2 MS'MS' MSMS The demand for and supply of money

62. Monetary Equilibrium Effects of changes in money supply on national income –effect on interest rates Ms   r  –effects of changes in interest rates on investment r   I 

63. Monetary Equilibrium Effects of changes in money supply on national income –effect on interest rates Ms   r  –effects of changes in interest rates on investment r   I  –effects of changes in interest rates on the exchange rate, and imports and exports r   er  X , M 

64. Monetary Equilibrium Effects of changes in money supply on national income –effect on interest rates Ms   r  –effects of changes in interest rates on investment r   I  –effects of changes in interest rates on the exchange rate, and imports and exports r   er  X , M  –effects of changes in investment, imports and exports on national income I , X , M   Y 

65. Monetary Policy The significance of monetary policy The policy setting –relationship between the government and the central bank –degree of central bank independence Medium- and long-term policy –control of banks’ liquidity ratio –restricting size of PSNCR

66. Monetary Policy Short-term monetary control –techniques to control money supply open-market operations reduced central bank lending to the banks funding variable minimum reserve ratios –techniques to control interest rates announcing changes in interest rates backing up announcements –operations in the discount and repo markets –credit rationing

67. Effectiveness of Monetary Policy Medium and long-term control over the money supply: reducing PSNCR –automatic fiscal stabilisers –the desire to cut taxes –difficulty in cutting government expenditure Short-term control of the money supply –use of money supply targets –ways in which banks resist attempts to restrict the growth in the money supply –demand-determined money supply

68. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates Effectiveness of Monetary Policy

69. O Demand for loans Q1Q1 Q2Q2 Assume that the authorities want to reduce the demand for money to Q 2 r1r1 Loans Rate of interest An inelastic demand for loans

70. r2r2 O Demand for loans r1r1 Q1Q1 Q2Q2 A large rise in the rate of interest (to r 2 ) will be necessary Loans Rate of interest An inelastic demand for loans

71. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans Effectiveness of Monetary Policy

72. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money Effectiveness of Monetary Policy

73. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money problem of changing expectations Effectiveness of Monetary Policy

74. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money problem of changing expectations speculation Effectiveness of Monetary Policy

75. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money problem of changing expectations speculation –possible conflict between domestic goals and exchange-rate goals Effectiveness of Monetary Policy

76. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money problem of changing expectations speculation –possible conflict between domestic goals and exchange-rate goals Using monetary policy Effectiveness of Monetary Policy

77. Effectiveness of controlling interest rates –inelastic demand for loans problem of possibly high interest rates reasons for an inelastic demand for loans –unstable demand for money problem of changing expectations speculation –possible conflict between domestic goals and exchange-rate goals Using monetary policy –use of interest rates to meet inflation target Effectiveness of Monetary Policy