Unit 27. Monetary policy (кредитноденежная политика)

Monetary policy is one of the main instruments of macroeconomics. It is based on the ability of the Central bank to control the money supply, which leads to changes in interest rates and the exchange rate, and therefore in the amount of investment, which influences directly the national output. This method of controlling the economy centres on adjusting the amount of money in circulation in the economy and so the level of spending and economic activity. Monetary policy was first employed as a means of control in the 1950s, but has been more widely used since the 1970s. The Central Bank plays a major role in the implementation of a nation's monetary policy. In some countries (for example, Germany) the Central Bank operates monetary policy independent of government policy. However, the UK's Central Bank, the Bank of England, implements monetary policy on behalf of the government. Monetary policy has three main aspects:

• Controlling the money supply

• Controlling interest rates

• Managing the exchange rate

In this section we study the ways in which a central bank can control the supply of money in the economy. The aim of the authorities when controlling the money supply is to limit the amount borrowed, and hence spent, by businesses and individuals during an inflationary period. It is hoped in this way to limit the level of overall demand in the economy and thus to remove or reduce inflationary pressure. During a recession monetary policy is aimed at increasing the money supply to encourage spendings. We now describe the three most important instruments available to affect the money supply: open market operations, reserve requirements and the discount rate.

Open Market Operations. Операции на открытом рынке

Open market operations are the most important way of controlling the money supply. It refers to the Bank trading government bonds in the open market  that is when they are bought from and sold to commercial banks and individuals.

When the Bank sells government bonds in the open market, the Bank withdraws the money from population and reduces the money supply. When the Bank buys government bonds in the open market, it increases the amount of money in circulation and hence the money supply.

Reserve Requirements. Резервные требования

To understand the way a central bank can influence the money supply we should consider the creation of money by commercial banks and in this connection introduce the money multiplier.

Banks have to hold a proportion of their assets as a reserve in case customers demand repayment of their deposits. This required reserve has to be in a liquid form, that is easily convertible into cash. Many banks indeed hold a significant proportion of this reserve as notes and coin either in their vaults or at the central bank. A required resen'e ratio (%) is a minimum ratio of cash reserves to deposits that the central bank requires commercial banks to hold. Commercial banks can hold more than the required cash reserves (this amount of money is called excess reserves and is used to create new money), but they cannot hold less. If their cash falls below the required amount, they must immediately borrow cash, usually from the central bank, to restore their required reserve ratio.

Commercial banks can make loans, i.e. they can create money and increase their excess reserves. Suppose somebody deposited $100 with bank A. II a required reserve ratio is 20%, the bank has $20 as required reserves and $80 as excess reserves, which can be lended. If a borrower draws a cheque for this whole sum and deposits it with bank B, then bank В gets $80 as its assets. Bank В is to hold 20% of this sum (that is $16) as required reserves. It means it has $64 of excess reserves, which it can lend to somebody. Tab! S illustrates the process with banks C, D, E, etc. being involved.