ECO 1302 Lecture Notes - Lecture 14: Money Multiplier, Monetarism, Fiscal Policy

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15 Mar 2017

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The interest rate on deposits at the central bank is the rate of interest that banks receive on their deposits at the bank of canada as a result of the operation of the lvts. The operating bank is the zone of overnight rate between the bank rate and the interest rate on bank deposits at the central bank. Settlement balances are the net aggregate amount of lvts balances held by banks, that is, a the sum of positive and negative lvts balances of all the banks. Base money is made up of two components of the liability side of the balance sheet of the central banks: currency, deposits received. We can say that there is a horizontal supply of base money at the target overnight interest rate. Open-market operations refer to the sale or purchase of government securities by the bank of.

Related Questions

In a country the monetary base is 1000. People hold one-fourth of their money in the form of currency (and thus three-fourths as bank deposits). Banks hold a third of their deposits in reserve.

a) What is reserve-deposit ratio, currency-deposit ratio, the money multiplier, and the money supply?

b) One day, Government passed a new rule that people needs to pay tax on their currency holdings, and people now want to hold one-fifth their money in the form of currency (and thus four-fifths as bank deposits). If the central bank does nothing, what is the money supply?

c) The central bank wants to conduct an open market operation to keep the money supply at its original level, does it buy or sell government bonds? Calculate how much the central bank needs to transact.

As we observed in this chapter, central banks, rather than purposefully setting the level of the money supply, usually set a target level for a short-term interest rate by standing ready to lend or borrow whatever money people wish to hold at that interest rate. (When people need more money for a reason other than a change in the interest rate, the money supply therefore expands, and it contracts when they wish to hold less.)

A. Describe the problems that might arise if a central bank sets monetary policy by holding the market interest rate constant. (First, consider the flexible-price case, and ask yourself if you can find a unique equilibrium price level when the central bank simply gives people all the money they wish to hold at the pegged interest rate. Then consider the sticky-price case.)

B. Does the situation change if the central bank raises the interest rate when prices are high, according to a formula such as R - R₀= a(P - P₀), where a is a positive constant and P₀a target price level?

C.Suppose the central bankâs policy rule is R - R₀= a(P - P₀) + u, where u is a random movement in the policy interest rate. In the overshooting model shown in Figure 15-12, describe how the economy would adjust to a permanent one-time unexpected fall in the random factor u, and say why. You can interpret the fall in u as an interest rate cut by the central bank, and therefore as an expansionary monetary action.

Does the situation change if the central bank raises the interest rate when prices are high, according to a formula such as R - R₀ = a(P - P₀), where a is a positive constant and P₀ a target price level?

ECO 1302 Lecture Notes - Lecture 14: Money Multiplier, Monetarism, Fiscal Policy

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