Read. Currency. Crypto currency.

Inflation. Inflation indices. FDI 7

cases major points, monetory
policy etc.Money marketAll in
detail and indirect questions not
direct answers from PPT. Read
beyond lines.
 Monetary Policy
OUTLINE
 What is monetary policy?
 How does it affect economy?
 Effectiveness of Monetary policy
 Issues in Monetary policy
MONETARY POLICY

 Primary target
 Intermediate targets
 Instruments
Primary target PRICE STABILITY

Intermediate targets

 Money supply
 Interest rates
 Exchange rate
Instruments
Direct:

 Interest regulations
 Credit controls
Market based:

 Discount rate
 Reserve ratio
 Open market operations
 INTEREST RATE

The interest rate is the amount of interest

paid per unit of time as a fraction of the
balance outstanding.

Fisher relation

REAL interest rate = NOMINAL

interest rate minus inflation
r=i-
 WHAT DETERMINES INTEREST RATES?
r
D1 S
D
r1
r
D1
D

A A1
I, S
r S
S1

E
E1 D
S
S1
I, S
INTEREST RATES AND ECONOMIC
ACTIVITY

 Substitution effect
 Income effect
 Wealth effect
 Investment effect
 Expansionary monetary policy

Higher money base

Lower interest rate

Growing private sector credit

Asset price More spending More output

inflation in short run

Consumer price increase

Capacity
constraint/
tight labour
Inflation market
MONETARY POLICY CAN SOMETIMES FAIL
Problem 1: Keynes’ liquidity trap where nominal interest
rates fall to such a low level that no further cuts are expected
(LM curve flat)
Problem 2: IS curve very steep, so outward shift of LM affects
interest rate but not output
Problem 3: If prices are falling, the real interest interest rate
rises, investment is deterred. Since nominal interest rates
cannot fall below zero, central bank powerless. The Japan
case.
LM & IS
What Is LM?
In macroeconomics terms, LM refers to the liquidity of money. As
interest rates increase, the demand for money decreases. LM is really
part of a larger model, the IS-LM model, where IS-LM stands for
Investment Saving - Liquidity Preference Money Supply. These large
words are basically just used to model money and income in an
economy.
The models are used to define points of equilibrium, or balance; in
other words, intersecting values where the demanded money equals
the amount available to invest.
ISSUES in MONETARY POLICY

 Active vs. passive

 Rules vs. discretion
 CB as a supervisor
 Transparency vs. secrecy
Conclusions:

1. Conservative view: “How much do we really

know about monetary policy?
Enough to prevent it doing harm, but not
enough to use it to do good.”
David Laidler, Taking Money Seriously, 1996
2. Monetary policy an art not a science. Secret
lies in responding in timely way (compare Japan
and US)
3. So far counter-cyclical policies have
prevented major and prolonged depression.
Will this continue?