Econ 2130 Money and Banking

09016937 Chan Yan Ki Gillry09018891 Kwok Man Kan Wendy09010521 Lau Tsz Kwan Larraine09008373 Leung Ho Sing Akira09021124 Wong Wing Ki Wallis

Newspaper Clip-China raises bank reserve ratio again

19th,November,2010

About the news• 19-Nov-2010

People’s Bank of China said that it will raise the required reserve ratio by 0.5%

The 4th time it raises the required reserve ratio this year

partly because of the quantitative easing2 in U.S.

• Quantitative easing2=the second round of quantitative easing

• Quantitative easing:a monetary policyaims to increase money supply (Ms)

by increasing excess reserves of the bank

About the news• U.S.: keep lowering the long-term interest

rateHot money will flow to other countries

• China: hot money inflow may hurt the economytake measures to cool down economic activities, slow down the growth in bank lendingtighten the liquidityavoid dangerous bubble in stock and real estate prices

• increase in required reserve ratioincrease in required reserve ratioachieve the goal??achieve the goal??

How the policy achieve the purpose • Increase in required reserve rat

multiplier =

Required reserve = r × checkable deposit

(r) ratio reserve required

1

How the policy achieve the purpose

• Required reserve• More reserve are need

• multiplier • Weaken the deposit expansion money supply ↓• less money will be lend out• Less Investment Result • Slow down the growth in bank lending• cool down the economic activities

How the policy achieve the purpose

• Decrease in Money supply interest rate increase

(money supply= currency + checkable deposit)

D = multiplier × excess reserve

How the policy achieve the purpose

• Interest rate ↑• Investment ↓• AD ↓• Price level ↓

Result• Control inflation • Avoid a dangerous

bubble in stock and real estate prices.

P

AS

AD 2

AD 1

output

Disadvantage

• some banks voluntarily have cash that exceed the amount of required reserves

• reserve requirement are not binding

• higher reserve requirements would not change the banks’ holdings of reserves

• no effect on the bank behavior

Disadvantage

• where reserve requirements are binding, requirements can cause immediate liquidity problems for banks

• fluctuating reserve requirements would also create more uncertainty for banks

Other ways to affect the Money supply• Open market operation to control monetary base

1)Open market purchase

↑ reserve, ↑ MB , ↑ MS

2)Open market sales

↓reserve , ↓MB , ↓MS

Open Market Operation

• It refers to the buying and selling of government securities by Central Bank.

• Aims:

- control short-term interest rate

- influence the supply of base money(money supply)

Open Market Operation

• Case 1:

Central Bank purchases govn't bond from the non-bank public with currency money supply interest rate

• Case 2:

Central Bank sells govn't bond from the non-bank public with currency money supply interest rate

Open Market Operation

• Advantages:

- Complete control

- Flexible and precise

- Easily reversed

- Implement quickly

• Limitations:

- Commercial banks keep surplus reserves

Other ways to affect the Money supply

• Discount loans

• ↑reserves in bank’s asset

↑Fed’s reserves in liabilities,

↑ monetary base

↑money supply

• But, change only a one-for-one .(if a bank pays off a loan thereby reducing the reserves)

Discount loans-lending

Discount loans-pay off

Other ways to affect the Monetary base(uncontrollable)

• Float fed clear checks debit it later change MB • Treasury deposits at the Federal Reserves US Treasury move deposit to fed’s

account reserves in banking system decrease MB decrease

THE END