Monetary policy

As monetary policy (also: monetary policy ) is called a summary of all economic policy measures taken by the central bank to achieve its objectives. The main instrument of monetary policy is the interest rate for central bank money. For a restrictive monetary policy interest rate is increased to raise the cost of borrowing and, for example, to dampen the economy. A reduction in interest rates reduces the cost of credit and to an expansionary credit policy of commercial banks to stimulate the economy to stimulate. In addition, a shortage of money supply contractionary / restrictive, an increase in the money supply an expansionary monetary policy.

  • 2.1 effects 2.1.1 impact in the short term
  • 2.1.2 Impacts in the medium term
  • 2.2.1 Investment case
  • 2.2.2 Liquidity Trap
  • 2.2.3 Money supply case
  • 2.2.4 Quantitative Easing
  • 3.1 Statement on the AS- AD model
  • 3.2 Statement on the IS- LM model 3.2.1 Effect within a closed economy
  • 3.2.2 Effects in an Open Economy

Objectives of monetary policy

The objectives pursued by the monetary policy can be distinguished as follows:

  • Parent, economic policy objectives: These arise usually from the central bank charter. The European Central Bank ( ECB) is price stability. The Central Bank of the United States ( the Federal Reserve System, or " Fed " ) has next to it a growth and employment objective. The ECB also has the secondary objective, to support the general economic policies. Sometimes central banks also pursue exchange rate targets.
  • Objectives of central bank policy: these are interim goals that are tracked in the fulfillment of the policy objectives. The intermediate target is an indicator of whether the economic policy objective can be met. This can be, for example, the money supply, the interest rate, inflation, economic growth, the price index or a combination of several objectives.

Economic policy objectives of monetary policy

Theoretical foundations

The role of money in economic activity and therefore the significance of monetary policy is controversial among economic schools.

The Classical economics assumes usually the neutrality of money. In other words, it looks in the money an important medium for transactions and assumes that it serves only as a " lubricant" - without repercussions on the real economy. In other words, whether and how much is produced, decides regardless of the monetary policy, influencing only the price level in the classic view.

Keynesianism is based on real economic consequences of monetary policy, monetary policy alone can not stimulate demand in a severe recession because the economy is then in a liquidity trap, in which the interest on bonds can not fall further. For Keynes, the interest rate was an important determinant of investment, hence the considered Keynesian monetary policy in terms of interest rate policy. Above all, Keynes was of the view that monetary policy in contrast to the classical view can not only about the money supply to control prices, but with a restrictive monetary policy takes the risk to cut down on wages and prices, a deflationary depression as trigger the Great Depression.

For monetarism, however, the monetary policy plays a key role. Instead of short-term interventions, he is in favor of predictable, steady conditions for the economy. The main goal is price stability. To ensure this, we recommend the representatives of monetarism a rules-based monetary growth.

Price level stability holds because of the negative effects of inflation on capital formation and growth as the main objective of monetary policy. Since inflation devalues ​​money assets and favors debtors, economic agents are not willing to save when inflation is high. That is why when inflation investing any money capital; it is made too little physical capital and interferes with the growth. In addition, a high inflation rate covers the signals emanating from prices to market events: If a product is more expensive, so it is unclear whether this only follows the general inflation, or because the demand increases then so that companies in the production to turn this good.

Aims into practice

Based on the different theoretical positions can be concluded that the central bank has mainly growth and employment targets in countries where a more Keynesian policies are pursued. In countries with monetarist orientation of economic policy that price stability is the focus. The distinction is not easy. Thus, in the identification of objectives, and past experience play an important role. In Germany, after two hyperinflations price stability is always an important goal, regardless of the general direction of economic policy.

IMF chief economist Olivier Blanchard has given the economic and financial crisis proposed to significantly raise the inflation targets of central banks from two to four percent. This push has sparked an international debate.

Intermediate targets of monetary policy

In order to achieve their policy objectives take the banks on the money supply and interest rates and so on financing conditions in the economy influence. They are based on intermediate targets that are ideally good and short-term observable while standing in a sufficiently close relationship to the economic objective. Common intermediate targets the money supply, interest rates, inflation itself, sometimes the exchange rate.

A monetary control as the German Bundesbank, for example, operational from 1975 until the transfer of monetary competence to the ECB, based on the assumption of monetarism, that the money demand is stable over time in an economy. Under this assumption can be calculated from the quantity equation is a simple rule to derive a monetary growth, which offers both sufficient scope for economic growth, on the other hand leaves no inflation: When economic growth, for example, at an average rate of 3% and keeps the central bank a inflation rate of 2 % is acceptable (or unavoidable ), the money supply needs to be extended in the long term at a rate of 5%. This prevents one hand, not the economy growing, on the other hand can be no unacceptably high inflation.

In an interest rate policy, the central bank tries to influence the interest rates on the capital market, which are crucial for the financing conditions for businesses and consumers. The capital market rates are the result of supply and demand and thus can be affected only indirectly by the central bank, by this affected by their monetary policy instruments the offer on the capital market. But there are particular with open capital markets and international capital mobility situations in which the central bank can not adequately influence the capital market interest rates.

A third possibility is a direct inflation targeting (direct inflation targeting ): central banks set an inflation target and observe the current rise in prices and factors that determine the future price increase (eg economic growth ). Do they see a threat to their inflation target, make them more restrictive monetary policy, that is, they take measures to restrict the circulation of money.

In particular for small countries with a large foreign sector, it may be useful to assign a monetary policy under an exchange rate target. Complete this subordination is in a currency board, in which the central bank can only bring so much money in circulation, as it has foreign exchange reserves.

The European Central Bank pursues a mixed strategy ( two-pillar strategy). It pursues an inflation target on the one hand, respects the other hand, but also to the money supply, indicating their long -term inflation risks.

Expansionary monetary policy

Expansionary monetary policy is a monetary measure of the expansion of the money supply or the money supply by a central bank. This will attempt to achieve economic goals. A shortage of money is called a restrictive monetary policy.

To achieve the objectives of monetary policy of the central bank is a set of monetary policy instruments at its disposal. She conducts open market operations, offers standing facilities and requires credit institutions deposit reserve requirements with her. Expansionary monetary policy is also the fact that the central bank buys, for example, in commercial banks and certain securities exchange. In the context of open market policy, the central bank also possible to purchase securities in the securities market. An expansionary monetary policy pursues the reduction of reserve requirements by the central bank, thus enabling the formation of excess reserves.

Effects

"The monetary policy is an effective tool for short-term stabilization of economic cycles. " Compared to the restrictive monetary policy is expansionary monetary policy made ​​in recessions in order to stimulate the economy. In the short term it has a real and quick effect on the production or the rate of interest, but in the medium term it is not working and in the end remains only a price level increase.

Impact in the short term

In the short term can be an expansionary monetary policy would reduce the interest rate and increase production and price levels. The production situation of an economy improved in the short term.

With the help of the IS-LM model and the AS -AD model shows the expansionary monetary policy as it affects the economic situation. It is first assumed that all markets are in equilibrium. This is point A, the intersection of the IS and LM curve in the figure: Expansionary monetary policy in the AS- AD model and the IS-LM model before the change in the nominal money supply. That is, the production is at its natural level Yn and the interest rate is equal to i This also corresponds to the equilibrium point A in the AS- AD model. An extension of the nominal money supply causes the shift of the LM curve to the right. In the AS- AD model, the aggregate demand also shifts to the right, from AD to AD '. Note, now the AD curve from the equation :: The increase in nominal money supply M makes the real money supply M / P to increase. This results in a new equilibrium at point A ' in both models. The net effect would be to lower interest rates on the money market and thereby appropriate stimulation of investment and production in the goods market.

Impact in the medium term

At the new equilibrium A ' is the production now on its natural level. As long as the output is above its natural level, the price level increases with the passage of time. This is due to the fact that additional production can decrease the unemployment rate and thus wages and prices rise. This, however, the real money supply M / P goes back further and further. The LM curve shifts along the IS curve further back up until it reaches its original position again. The interest rate steadily increases again, investment demand and production go back accordingly. With the steady expansion of price expectations, the aggregate supply curve shifts so over time upward along the aggregate demand AD ' until it reaches the point A ''. This then means that the natural level of output reflects the expected price level, so the adjustment process ends. In the medium term the aggregate supply curve is given by AS ''. The economy is located at point A '': The production is again equal to Yn, only the price level is higher at the point P ''. In the medium term, the increase in the nominal money supply suggests fully reflected in a proportional increase in the price level, that is, the change in the nominal money supply affects the medium term neither production nor interest rate, but only the price level; this is also known as the neutrality of money in the medium term.

Problem cases

However, there are special cases in which the expansionary monetary policy is ineffective:

Investment case

IS- curve is vertical, the elasticity of the investment is zero. An expansionary monetary policy shifts the LM curve to the right. The investment amount does not change, even if the interest rate decreases. The expansionary monetary policy has no effect on investment. This may arise due to negative future or expected returns of the investment.

Liquidity trap

An expansionary monetary policy leads to a rightward shift of the LM curve, but the interest level remains as before, since it has already reached a low point and extra money is held only in liquidity rather than investing. The investment is not stimulated. Thus under this case is expansionary monetary policy is also ineffective.

Money case

In this constellation, an expansionary monetary policy has the opposite effect. If the central bank increases the money supply too much about the fixed targets addition, a rise in interest rates will follow the price increase. This leads to an increase in the nominal interest rate. Now the expansionary monetary policy affects even restrictive. And the central bank can not add an easing signal in the ground.

Quantitative easing

If the base rate of the Central Bank already reduced to zero, the central bank can try to continue to operate on quantitative easing an expansionary monetary policy - such as the Bank of Japan from 2001.

Contractionary monetary policy

The contractionary monetary policy includes all measures which the money supply, that is the amount of money in circulation is reduced. A central bank can use open market operations to reduce the monetary base. This is typically done on the sale of securities for cash. With the appearance of this cash it deprives the economy of money and thus reduces the monetary base. Contractionary monetary policy can be carried out by the Central Bank of the commercial banks calls the attitude of a higher minimum reserve. Banks hold only a fraction of their assets for immediate cash withdrawals in cash. The rest is invested in non-cash, such as loans or mortgages. Especially in times of economic overheating, the contractionary monetary policy is an effective tool. It leads to increases in interest rates, production and investment fall and helps reducing the risk of increased inflation.

Declaration on the AS- AD model

The AS- AD model combines the total supply ( aggregate supply ) and the total demand ( aggregate demand ). It thus brings together the labor, goods and the money market and describes the interactions of production and price levels.

AS curve:

It describes the total supply on the basis of the labor market with the following meanings:

  • P = actual price level
  • Pe = expected price level
  • μ = variable structure of the goods market ( degree of completeness of the competition on market: → perfect competition, generally, the larger μ, the higher the degree of monopolization )
  • Y = income
  • L = number of employed persons
  • Z = variable structure of the labor market (which includes all the features that make up the structure of the labor market, such as: working conditions, protection)

AD curve:

It is the unification of IS and LM curve ( see below), where:

  • Y = level of production
  • M = nominal money supply
  • P = price level
  • G = government spending
  • T = tax

The operations, which triggers a reduction in money supply, will now be explained:

To better understand the designs should be said that the production over time tend to adapt to the natural level of output Yn ( production capacity at normal employment). At this point, the actual price level equal to the expected price level.

The reduction in the money supply only affects the demand curve, since the total supply is independent of the monetary base. Starting from a production at normal capacity utilization also leads the nominal money reduction to a real reduction in money, since the price level remains constant for the time being. The money supply is declining, the total demand decreases ( shift the AD curve to the left). This reduces the production and the price level falls to P '. Due to the decline in production, the production is now below its normal level. This results in a reduction of employment consequence. Furthermore, the actual price level is now below the expected. These facts lead to changes in price expectations. Wages are revised downwards. Due to this, finally changed the overall supply. The curve shifts downward as prices fall. Actual and expected prices as long as adapt, to the natural level of output is reached again (A '').

One must distinguish between short and medium term. Short term is due to the reduction in money demand recedes. Production and price level from falling. Medium term, the production returns through further price adjustment back ( reaction of the offer ) to its natural level. But the price level is lower.

Declaration on the IS- LM model

The IS -LM model represents the relationship between goods and money market dar. this case, the goods market is described by the IS function and the money or financial market by the LM function. The goal of this model is the explanation of the interactions of income (or production ) and interest.

Impact within a closed economy

In a closed economy, there are no economic relations with foreign countries, which means there is no cross-border trade relations.

IS curve:

It represents the equilibrium in the goods market dar. Where:

  • Y = Production
  • C = consumption (income - taxes)
  • I = investment, depending on income and interest rate
  • G = government spending

LM curve:

It describes the equilibrium in the money market, where:

  • M = nominal money supply
  • P = price level
  • Y = income
  • L (i) = demand for liquidity, depending on the interest rate

The workings of a money supply reduction will now be explained in the model:

Since the money supply has no effect on the IS curve, monetary policy act only on the LM curve in the form of a shift. By reducing the nominal money supply takes place, due to the fact that the price level remains constant, and a decrease in the real money supply. Thus, the money supply is declining, which, at a constant demand an interest rate increase of moves to be. For any income now is the interest rate, which leads to a money market equilibrium, higher. The LM curve thus shifts upward. It comes to a new equilibrium A ', in the now less income is available, which leads to a reduction in consumption. This sequence and the newly declared interest rate increase will result in a decline in investment and production.

This model is based on a constant price level, that is the nominal money supply reduction is equal to the real money supply reduction. Taking into account the remarks of the AS -AD model can be seen that the price level adjusts the medium term. The lowering of the nominal money supply moves accordingly after some time the fall in the price level by itself. Thus, the real money supply rises again. The impact of monetary reduction are partially offset. The LM' curve shifts back towards the LM curve (on presentation of this effect in the figure is omitted for clarity ). The initial impact on the interest rate from the sound.

Effects within an open economy

An open economy is characterized by active trade relations with other countries in terms of exports and imports

IS curve:

It represents the goods market equilibrium dar. where:

  • Y = Production
  • C = consumption (income - taxes)
  • I = investment, depending on income and interest rate
  • G = government spending
  • NX = net exports ( value of exports - value of imports ), depending on the domestic and foreign production and the exchange rate

LM curve:

It describes the equilibrium in the money market, where:

  • M = nominal money supply
  • P = price level
  • Y = income
  • L (i) = demand for liquidity, depending on the interest rate

The effect of contractionary monetary policy can be described as follows:

In principle, the processes are similar to that of a closed economy. The reduction in the money supply ( domestic) affects only the LM curve, which leads to a decrease in the money supply and a rise in interest rates. These interest rate increase resulted directly in a drop in production. In contrast to the closed economy but also the exchange rate plays a crucial role. An increase in the domestic interest rate causes according to the interest rate parity relationship is also a rise in the exchange rate. Since a rise in interest rates increases the attractiveness of the securities, want many (foreign) investors to invest in this, with the result that they need to exchange their foreign currency in domestic currency. Thus, the domestic currency experiences a revaluation, which has the relative increase in the price of domestic over foreign goods result. The demand for domestic goods is falling, the production decreases. Consequently, the rise in interest rates affects one directly and one indirectly (through the exchange rate ) negative impact on production. This decrease due to the reduction in the demand for money, leading to a fall in the interest rate and thus the effects just illustrated partly offsetting. The LM curve tends back towards its original position LM ( see Figure IS- LM model in a closed economy ).

Summary of the effect of the tools

An increase ( / decrease) in the reserve requirement ratio solves ideally following reactions:

  • Commercial banks may be less (more) produce deposits ( credit for credit ), assign lower (larger) volume of loans to individuals, businesses, public sector - creation of money decreases (increases ).
  • The money supply decreases (increases ) by.
  • A lower (higher ) money in circulation attenuates ( increased) inflation ( for the same amount of goods ), as demand decreases (increases ).
  • Since less (more) credit money can be drawn, increases (decreases ) the interest rate (in theory, without taking into account interest rates ); Interest rates are the price of money, so a shortage indicator.
  • Higher interest rates (lower ) dampen economic growth ( stimulate the economy ).
  • At a higher ( lower ) interest rates will be more ( less) savings and less (more) consumed and invested.
  • Higher interest rates (lower ) lead to capital imports ( exports - ) and thus to an appreciation (depreciation ) of the domestic currency.
  • Appreciation ( depreciation ) attenuate ( increase ) inflation and economic growth in addition.

An increase ( / decrease) in the refinancing rate has the following result:

  • It is for banks more expensive ( cheaper) to provide themselves with the central bank with central bank money
  • Enter the higher ( lower ) interest rates to their customers.
  • There will be less (more) lend.
  • Volume of money in circulation as to fall ( rise) by it.
  • A lower (higher ) money in circulation attenuates ( increased) inflation ( for the same amount of goods and constant employment).
  • Higher interest rates (lower ) lead to capital imports ( exports ) and thus to an appreciation (depreciation ) of the domestic currency.
  • Appreciation ( depreciation ) attenuate ( increase ) inflation and economic growth in addition.

An increase ( / decrease) the interest on securities does the following:

  • It is more lucrative for banks ( less lucrative ), securities (assets) to " buy " ( money creation in buying assets).
  • The purchase ( sale) of assets increases ( decreases ) the equity ratio of credit institutions.
  • Higher (lower ) interest on securities are typically based on higher (lower ) risk, for which higher weighted ( lower -weighted ) equity demands ( accepted) shall (Basel II, Basel III) and thus raise the higher (lower ) attractiveness of higher ( lower ) interest rates possibly. upon.
Economic indicator Interventionism (politics) AD–AS model Monetary economics Handelsblatt
322844
de