2/21/2024

Financial Economics
Vu Huu Thanh (PhD.)
Chapter 3. Interest rate and monetary policy

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1 Four players in the money supply process

1. The central bank—the government agency that

oversees the banking system and is responsible for
the conduct of monetary policy.
2. Banks (depository institutions)—the financial
intermediaries that accept deposits from individuals
Terminology:
THE MONEY SUPPLY PROCESS and institutions and make loans: commercial banks, • Central bank: Ngân hàng
savings and loan associations, mutual savings banks, trung ương.
and credit unions • Depositors: Người gửi tiền
3. Depositors—individuals and institutions that hold
deposits in banks.
4. Borrowers

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2 Money Supply (MS) Process

• Money supply (MS) processrefers to the
mechanism that determines the money supply.
• It refers to the implementation of monetary policy.
• It is important to understand the MS Process to
understand exactly how open market operations
(OMOs) change the money supply, and thereby
affect the economy (interest rates, inflation,
output, employment, money, etc.)
The Central Bank's Balance Sheet (BS) and the
Monetary Base (MB)
Terminology: In this simplified version of the Central bank’s BS, we will focus on only 4
items to see how they affect the economy’s money supply.
• Monetary policy: Chính sách
tiền tệ
• Open market operations: Thị
trường mở

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3 Other Factors That Affect the Monetary Base 4 Factors that determine the money supply

• Two important items that affect the monetary base, but are not controlled by the
Fed, are float and Treasury deposits atthe Fed. • Changes in the Nonborrowed Monetary Base Terminology:
• When the Fed clears checks for banks, it often credits the amount of the check to
• Changes in Borrowed Reserves • Monetary Base: Tiền cơ sở
a bank that has deposited it (increases the bank’s reserves) before it debits
(decreases the reserves of) the bank on which the check is drawn. • Changes in the Required Reserve Ratio • Required Reserve Ratio: Tỷ
lệ dự trữ bắt buộc
• The resulting temporary net increase in the total amount of reserves in the • Changes in Excess Reserves
banking system (and hence in the monetary base) caused by the Fed’s check- • Excess Reserves: Dự trữ
clearing process is called float. • Changes in Currency Holdings vượt mức

• When the U.S. Treasury moves deposits from commercial banks to its account at
the Fed, leading to an increase in Treasury deposits at the Fed, it causes a
deposit outflow at these banks

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1 Open Market Operations:

• The most important conventional monetary policy

tool because they are the primary determinants of
TOOLS OF MONETARY POLICY: changes in interest rates and the monetary base,
the main source of fluctuations in the money
CONVENTIONAL TOOLS supply.
• Open market purchases expand reserves and the
monetary base, thereby increasing the money
supply and lowering short-term interest rates.
Terminology:
• Conventional monetary policy
tool: Công cụ truyền thống để
điều hành chính sách tiền tệ.
• Short-term interest rates: Lãi
suất ngắn hạn

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1 Open Market Operations: 1 Open Market Operations:

Open market operations fall into two categories:

Terminology:
• Dynamic open market operations are intended to Terminology: Defensive open market operations are of two basic
types: repurchase agreement (often called a repo), • Repurchase agreement
change the level of reserves and the monetary (repo): Thỏa thuận mua lại.
• Dynamic open market
base, and sale–purchase transaction (sometimes called a
operations: Nghiệp Vụ Thị
reverse repo) • Reverse repo: Thỏa thuận
• Defensive open market operations are intended to Trường Mở Năng Động mua lại đảo ngược
offset movements in other factors that affect • Defensive open market
reserves and the monetary base, such as operations: Nghiệp Vụ Thị
Trường Mở Thụ Động
changes in Treasury deposits with the Fed or
changes in float.

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2 Discount Window 3 Lender of Last Resort

The facility at which banks can borrow reserves Lender of last resort: to prevent bank failures from
from the Federal Reserve is called the discount spinning out of control. Terminology:
window. Terminology:
In performing the role of lender of last resort, the • Lender of last resort: Người
• Discount Window: Cửa sổ
Operation of the Discount Window The Fed’s chiết khấu
Fed must use the discount tool wisely when cho vay cuối cùng.
discount loans to banks are of three types: primary attempting to thwart financial panics. This is an • Financial panics: Hoản loạn
credit, secondary credit, and seasonal credit extremely important aspect of successful monetary tài chính
policymaking.

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4 Reserve Requirements 5 Interest on Reserves

• A rise in reserve requirements reduces the

amount of deposits that can be supported by a
given level of the monetary base and leads to a
contraction of the money supply.
• A rise in reserve requirements also increases the
demand for reserves and raises the federal funds
rate. Conversely, a decline in reserve
requirements leads to an expansion of the money
supply and a fall in the federal funds rate
• One is when the Fed wants to raise interest rates
after banks have accumulated large amounts of
excess reserves.
Terminology: Terminology:
• In this case, the federal funds rate can be raised
• reserve requirements: Dự trữ • Interest on Reserves: Lãi
by increasing the interest on reserves, which
bắt buộc suất trả cho dự trữ
eliminates the need to conduct massive open
market operations to raise the federal funds rate
by reducing reserves.

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1 Liquidity Provision

• Discount Window Expansion

• Term Auction Facility
TOOLS OF MONETARY POLICY: NONCONVENTIONAL • New Lending Programs
TOOLS AND QUANTITATIVE EASING

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2 Large-Scale Asset Purchases 3 Negative Interest Rates on Banks’ Deposits

• The Fed’s open market operations normally involve only the purchase of
government securities, particularly those that are short-term. However, during
the crisis, the Fed started two new, large-scale asset purchase programs
(often referred to as LSAPs) to lower interest rates for particular types of
credit.
• With inflation very low and their economies weak after the global financial crisis,
central banks in Europe and Japan recently began experimenting with a new
nonconventional monetary policy tool, setting interest rates on deposits held by
banks at their central banks to be negative. In other words, banks now had to
pay their central bank to keep deposits in the central bank.

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1 The main goal of monetary policy

• Price stability: low and stable inflation, is increasingly viewed as the most
important goal of monetary policy.
• Nominal anchor—a nominal variable, such as the inflation rate or the money
THE CONDUCT OF MONETARY POLICY supply, that ties down the price level to achieve price stability

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2 Other goals of monetary policy

• High Employment and Output Stability

• Economic Growth
• Stability of Financial Markets
• Interest-Rate Stability
• Stability in Foreign Exchange Markets
Thank you!

Vu Huu Thanh (PhD) 26

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