MONETARY POLICY FRAMEWORK Jamshed uz Zaman. Major Divisions of the Economy If our economy were a...
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Transcript of MONETARY POLICY FRAMEWORK Jamshed uz Zaman. Major Divisions of the Economy If our economy were a...
MONETARY POLICY FRAMEWORK
Jamshed uz Zaman
Major Divisions of the Economy
If our economy were a circle then one half of it would be real sector and the other be Financial sector.
Real Sector
Economy
Financial Sector
The real sector is dealt with by many ministries, while ministry of finance and central bank deal with the financial sector
Real Sector
Economy
Financial Sector
Ministry of:
•Agriculture,
•Industries
•Energy and natural resources
• Commerce
•Communications
•Water resources
Etc.
• Ministry of Finance,
•Bangladesh Bank
Output of the real sector is GDP(Y) while that of financial sector is money (MV) Interaction between the sectors
determine the price level (monetarists concept)
GDP(Y)
Output of the Economy
Money(MV)
YMVP
When Y P and When MV P
In Bangladesh the relationship is weak and is not co-integrated. (Ref: Tobin)
0
5
10
15
20
25
0
2
4
6
8
10
12
14
M2 Growth
Inflation (yoy)
Targets of Monetary Policy
Inflation targeting (NZ), Interest rate targeting, Exchange rate targeting, Etc.In Bangladesh we target Quantity of
Money in accordance to the Government targets of GDP growth rate and inflation rate.
In targeting quantity of money, how we determine the right quantity of money?
PY = yOr, y(1+Δy)=P(1+ΔP) Y(1+ ΔY)Or, Δy=(1+ΔP) (1+ ΔY)-1Or, ΔM = ξ[(1+ΔP) (1+ ΔY)-1]
Where PY is GDP at current prices and y is at constant prices. Δ indicates percentage changes
ξ = ΔM/Δy Income elasticity of money demand
Equation of Money demand with money supply
Md = Ms
If Md < Ms then inflationIn log term,Md = b0 + b1 GDP + b2 expected inflation.
Md = -11.3 + 2.59 GDP + 0.014 expected inflation.
Statistical properties including ADF and Johanson co-integration tests are OK.
Instruments to control money supply
Bank Rate Reserve requirements (SLR/CRR), Open Market Operation (repo,
reverse repo, T-bills, BB-bills) Open Mouth Operation (moral
suasion).
Definition of Money Supply: Who Creates Money
M1 = C + DD …….Liquid, Means of Payments
M2 = C +DD+TT… Not Instantly liquid
M3 = large negotiable deposits, repurchase agreements (USA), deposits of other financial institutes (Bangladesh)
C = notes and coinsSource of C are:
Central Bank and Government
Why Treasury (Gov.) Creates Currency?Chapter 13
Reserve Money and Money Multiplier
M = C + D H = C + RDividing by DM/D = cu + 1H/D = cu + recu assumed to be constantre =f(i, iD, rR, σ)
- + + +
Interest rate, discount rate, required reserve, uncertainty
It is easier to target Reserve Money than to target Money Supply
M/H = mmM = mm.HH = High powered moneyM = Money supply and mm =money
multiplier which is assumed to be constant.
Chapter 14
Supply Side (contd.)
Since,M/H = (C + D)/(C + R)Dividing by DM/H = (cu +1)/ (cu + re)M = [(cu +1)/ (cu + re)].HMm = (cu +1)/ (cu + re)Therefore, M = mm.H
Equilibrium in the Money Market
Demand for Money M/P = L(i, Y)
Supply of Money M/P = mm((i, iD, rR, cu, σ)
Equilibrium
mm((i, iD, rR, cu, σ) = L(i, Y)
Equilibrium and Shift in Curve
Equilibrium and Shift in Curve
Slow and limited response of the policy initiative is attributable to the following reasons:
• The transmission mechanism of monetary policy stance, i.e., how, when and through which channel the policy initiatives works in Bangladesh, is still unidentified.
• We have limited information about the requirement of money needed for financial deepening and monetization process. This creates a problem of estimating money demand.
• Change in Net Foreign Assets is often exogenously determined and we do not have sufficient sterilization mechanism.
Transmission Mechanism
(1) (2) (3) (4)
Changes in real money supply
Portfolio adjustments lead to a change in asset prices and interest rates
Spending adjusts to the change in interest rates
Output adjusts to the change in aggregate demand
Necessity of Monetary and Fiscal Policy Mix
Monetary policy instruments can exert their influence only on private sector credit, which explains only a part of total changes in money supply. This can be explained by the following equation:
ΔM = ΔCredit to Gov + ΔCredit to other Public Sector + ΔCredit to Private sector + ΔNet Foreign Assets + ΔOthers.
In Bangladesh, changes in credit to the government and to other public sector are beyond any monetary policy stance. Mainly because of this Actual level of Money remains at higher level than the Programmed level at times of fiscal mismatch.
Under developed Financial Market and NPL
• The BB's capacity to implement monetary policy is constrained by the nature of the financial market, which is yet to develop.
Programmed and Actual Reserve Money
250
270
290
310
330
350
370
390
410
430
Jun-05 Sep-05 Dec-05 Mar-06 Jun-06 Sep-06 Dec-06 Mar-07 Jun-07 Sep-07
Bill
ion
Taka
Actual
Programmed
BB’s Initiatives to Develop Financial Market
Move towards market based monetary and credit management
Improvement in legal and judicial processes,
Improvement in prudential regulations and governance.
As a result:1990-1999 GDP growth rate 4.8 percent,
Inflation 7.06 percent2000-2006 GDP growth rate 5.6 percent,
Inflation 4.40 percent
Interest rates and Exchange rates were floated
Interest rates were floated in early 1990s
Exchange rate was floated in 2003.
Movement of Taka against USD
55
5759
61
63
6567
69
7173
75
03-07-
0423-
08-04
14-10-
0413-
12-04
08-02-
0504-
04-05
29-05-
0519-
07-05
08-09-
0517-
11-05
24-01-
0629-
03-06
04-06-
0602-
08-06
05-10-
0612-
12-06
18-02-
0724-
04-07
27-06-
0728-
08-07
06-11-
0714-
01-08
Taka p
er USD
Lending Rates: All Banks
Present Monetary Policy Stance
BB is now announcing its monetary policy every six months.
BB’s policy is to encourage higher and sustainable growth (by providing credit to productive sector) with restrained inflation rate.
To achieve this, indirect monetary control instruments are being used. Crude and direct methods are avoided.
Repo, reverse repo rates and t-bills/bond, BB-bills yield rate are the main policy instruments.
Development of financial sector. Capacity building in the Bangladesh Bank.
Repo, Reverse Repo, Call Rate
Yield on Treasury Bills
Excess Liquidity
Deficit Financing
Thank You