1

النقدية والسياسة والبنوك النقودMoney, Banking System, Central Bank

and Monetary Policy

لجزء الثامنا

2

Recall, there are many policies that can applied to change a GDP gap or to generally change the real GDP and the price level. One of these policies is the Fiscal Policy. The other policy is monetary policy.

Monetary policy: policy by the central Bank to adjust and control the quantity of money in circulation (money supply) through different tools to influence GDP growth, the general price level and other macroeconomics variables.

: النقدية في السياسة للتحكم المركزي البنك يتبعها سياسة ( مختلفة ( أدوات باستخدام االقتصاد في النقود كمية عرض

ومتغيرات األسعار ومستوى االقتصادي النمو على للتأثيرأخرى كلية اقتصادية

3

To understand the operation of the monetary policy, we needto understand the definition and function of money,commercial banks, and the central bank.

من كل وظائف وفهم تعريف نحتاج النقدية السياسة لفهم. و، النقود المركزي البنك و التجارية البنوك

4

Q: What is money ?A

FEDERAL RESERVE NOTE

THE UNITED STATES OF AMERICATHE UNITED STATES OF AMERICA

L70744629F

12

1212

12

L70744629F

ONE DOLLARONE DOLLAR

WASHINGTON, D.C.

THIS NOTE IS LEGAL TENDER

FOR ALL DEBTS, PUBLIC AND PRIVATE

SERIES

1985

H 293

Money: anything that is generally accepted as a means of payment (in the exchange of goods & services)

تتمتع: و والخدمات السلعي للتبادل تستخدم وسيلة أي النقودالعام بالقبول

Money: anything that is generally accepted as a means ofpayment (in the exchange of goods & services)

تتمتع: و والخدمات السلعي للتبادل تستخدم وسيلة أي النقودالعام بالقبول

First: Money First: Money

5

Functions of Money:

1- Medium of exchange

2- Unit of account

3- Store of value

4- Standard of deferred payment) ( اآلجل للدفع وسيلة

Q1: What is meant by money illusion?

Q2: What is meant by currency substitution?

6

(1) Narrow definition: financial assets that are the mostliquid : M1 = currency in circulation (coins & papers in the hands of the public ) + Demand deposits (+ traveler's checks)

(2) Broad definition: M2 = M1 + Saving and time deposits (in commercial banks

(3) Broad definition: M3 = M2 + time deposits in other financial institutions

Q: What is meant by quantity of money (money supply)?And how to measure it ?

7

Note: part of the quantity of money is held by commercial banks as demand and time deposits.

In Kuwait (2000):

M1: KD 1467.7 mM2: KD 6695.5 mM3: KD 8175.2 m

8

Functions of Commercial Banks

1- Accepting deposits

2- Lending money

3- Other banking services

4- Money creation ( خلق (النقود

Second: Commercial Banks Second: Commercial Banks

9

Required reserve ratio

الفائدة: أسعار فرق هو التجارية البنوك أرباح من كبير جزء مالحظة . التجارية البنوك صالح من إذن الودائع على الفائدة أسعار عن القروض على

على . يحافظ بما العملية هذه لتنظيم لديها الودائع حجم من قدر أكبر إقراض . القانوني االحتياطى بنسبة يعرف ما بفرض المركزي البنك يقوم المودعين، حقوق

)Required reserve ratio(

Required reserve ratio (RRR): percentage of deposits that is required by the central bank to keep as reserves.

على : المركزي البنك يفرضها نسبة القانوني االحتياطي نسبة. كاحتياطى وديعة كل من بها يحتفظ التجارية البنوك

10

Example: if RRR=10% , of an initial deposit = KD100Required reserves = 100 * 10% =10 ( القانوني ( االحتياطىExcess reserves = 100 -10 = 90 ( الفائض ( االحتياطى

Note: If the bank was able to lend KD 60 of its excess reserves, what is the total reserve this bank has ?

Total Reserve = Required reserves + Excess reserves ( الفائض القانوني ) (االحتياطى الكلي ) (االحتياطى ( االحتياطى = 10 + 30 = 40

11

Money creation is based on the process of deposits & loans and the RRR. To explain this process we assume:

1- All Commercial Banks will apply the RRR 2- All banks will lend their excess reserves

3- No currency leakage out of the banking system

Money Creation

: القانوني، االحتياطى بنسبة التجارية البنوك التزام نفترض النقود خلق عملية لشرحالمصرفي الجهاز من تسرب أي وجود وعدم لديها، النقدية الفوائض جميع بإقراض البنوك وقيام

12

100

10 90

1000

100A

90B

Required Reserves Excess ReserveDepositsBank

900

6.5665.61E 59.05

7.2972.9D 65.61

8.181C 72.9

9 81

Example: RRR= 10% , an initial deposit = KD 100

13

Money Multiplier (Deposit expansion multiplier):( االئتمان / مضاعف النقود (مضاعف

Mm = 1

RRR

The multiplier: maximum possible change in total depositsout of any new deposit created by a multi-bank system.

Potential money creation = initial deposit x Mm

14

Q: What will happen to the effect Mm

when : A: there is a leakage (money drain) from the banking system?

B: Banks were not able to lend all their excessreserves?

C: Banks fail to apply the RRR?

15

Example1:

IF RRR= 20%, and an initial deposit = KD 7000 was deposited at Alnoor Bank. What is the maximum Value of loans can this bank lend ? What is the maximum value of loans can the banking system create out of this deposit ?

1400 56007000Alnoor

Required Reserves Excess ReserveDeposits

Since Mm = 1/20% = 5

Total loans (by the banking system) = 5600 x 5 = 28000

Answer :

16

Example2:

IF RRR= 10%, and a commercial bank has deposits = KD 50,000 and total reserves = KD 7000 What is the value of excess reserves this bank has ?

Required reserves = deposit x RRR = 50,000 x (10/100) = 5000Excess reserves = Total reserves - Required reserves = 7000 – 5000 = 2000

Answer :

17

Third: Central Bank Third: Central Bank

Functions of the Central Bank

1- Issuing the national currency

2- Banker’s Bank (maintain cash deposits , reserves, transferring funds and checks between banks, imposes regulations on banks, lender of last resort).

4- Implementing monetary policy (through monitoring and controlling money supply)

3- Government bank (handling payroll accounts, financial consultant & representative)

18

المركزي البنك وظائف

الوطنية -1 العملة اصدار

2- : واالحتياطي، بالودائع االحتفاظ البنوك بنكلإلقراض األخير الملجأ المقاصة، عمليات إدارة

3 - : االلتزامات سداد و إدارة الحكومة بنكمستشار ، للحكومة والخارجية الداخلية المالية

، الخارجية النقدية تعامالتها في وممثلها الحكومة . الحكومية بالودائع االحتفاظ

في- ( 4 التحكم المالية السياسة وتنفيذ رسمالنقود (عرض

19

Tools of Monetary Policy

1- Discount rate ( الخصم the interest :(سعرratethat the central bank charges the commercial banks.

3- Open market operation: the purchase and sale of government securities (bonds) by the central bank ( الحكومية السندات وشراء (بيع

2- Required reserve ratio.

20

Note: To understand how these tools can affect macro economic activities, we first view the impact of changes in money supply.

Factors affecting demand for money:( النقود على الطلب على المؤثرة (العوامل

Factors affecting investment and consumption expendituresuch as: income, interest rate, expectation ..etc.

Factors affecting supply of money:( النقود عرض على المؤثرة (العوامل

Factors affecting saving decisions and central bank policysuch as: income, interest rate, macroeconomic conditions

21

Now assuming all factors constant except interest rate, then money demand is inversely related to interest rate, while money supply is positively related to interest rate

الفائدة سعر بين العالقة فإن األخرى، العوامل جميع ثبات بافتراضبعرض الفائدة سعر وعالقة ، عكسية عالقة هي النقود على والطلب

طردية عالقة النقود

Qm

i

Md

Ms

i

q

22

Qm

i

Md

Ms

i

q

If the central bank increases the money supply lowerinterest rate stimulate consumption and investmentexpenditure , i.e increases AE (other things equal)

Ms2

i2

q2

Note: This is an expansionary monetary policy that can be applied to increase AE (e.g in case of a deflationary gap)

23

Qm

i

Md

Ms

i

q

If the central bank reduces the money supply raise interest rate reduced consumption and investment expenditure , i.e reduce AE (other things equal)

Ms2

i2

Note: This is a contractionary monetary policy that can be applied to reduce AE (e.g in case of an inflationary gap)

q2

24

First: If an economy is facing a deflationary gap, the central bank can increase money supply, i.e applying an expansionary monetary policy ( نقدية سياسة(توسعية

An expansionary monetary policy tools:

1- Reducing discount rate : reduce interest rate stimulate consumption & investment expenditure increase AE

25

An expansionary monetary policy tools:

2- Reducing RRR : increase money supply lower interest rate stimulate consumption & investment expenditure increase AE

3- Buying government securities : increase money supply lower interest rate stimulate consumption & investment expenditure increase AE

26

Second: If an economy is facing an inflationary gap, the central bank can reduce money supply, i.e applying a contractionary monetary policy ( نقدية سياسةإنكماشية

a contractionary monetary policy tools:

1- increasing the discount rate : increase interest rate lower consumption & investment expenditure lower AE

27

A contractionary monetary policy tools:

2- Raising RRR : reduce money supply raise interest rate reduce consumption & investment expenditure reduce AE

3- Selling government securities : lower money supply raise interest rate reduce consumption & investment expenditure reduce AE

28

Possible obstacles to effective fiscal & monetary policies:

1- Possible time lags in policy implementation(more for fiscal policy)

2- Possible crowding out effect (as the government borrows to finance the deficit, interest rates increases and crowds out investment expenditure

3- Possible fiscal & monetary coordination problems

29

4- Lack of full control over some domestic andinternational economic variables. (e.g lack of control over international money movement, investors & consumers expectations, social & political changes)

5- Limitations of accurate economic forecasting of dynamic economic variables.

Q: What policies should be applied in case of stagflation?