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Money _ Central Banks

VIEWS: 39 PAGES: 66

  • pg 1
									Central Bank Balance Sheet and
  the Money Supply Process
          Chapter 17
        Banking Regulation
• Many central banks require banks to keep
  some fixed fraction of checking deposits
  as deposits at central bank.
• Required reserve ratio - 0 ≤ rr < 1.
• China most prominently uses the reserve
  ratio as a measure of monetary policy.
                   Country          Required reserve ratio %
  Required         Australia        None
  Reserve Ratios   Canada           None
                   Mexico           None
  From Around      New Zealand      None
  the World.       Sweden           None
                   United Kingdom   None
                   Eurozone                                 2
  Wikipedia        Slovakia                                 2
                   Switzerland                            2.5
                   Chile                                  4.5
                   Pakistan                                 7
Hong Kong 0        Latvia                                   8
                   India                                    9
                   United States                           10
                   Sri Lanka                               10
                   China                                 17.5
                   Estonia                                 15
                   Croatia                                 19
                   Jordan                                  80
                20
                   05




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                                                          16



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                                                               Reserve Ratio




                     .0
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                     .




Reserve Ratio
                20 11
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                     .
                20 01
                   07
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                20 03
                   07
                     .
                20 05
                   07
                     .
                20 07
                   07
                                                                                Reserve Requirement




                     .
                20 09
                                                                               People’s Bank of China




                   07
                     .1
                       1
     Money Supply The stock of the medium of
      exchange supplied by the central bank.

               Types of Financial Assets

M1    Currency in Hands of the Public [C] + Demand
      Deposits [D]


M2    M1 + Savings Deposits + “Small” Time Deposits +
      [Liquid Money Market Instruments inc/ “Small” NCD’s]


M3    M2 + LTD [“Large” Time Deposits and NCD’s]
         The Monetary Base
• The monetary base, also called “high powered
  money” consists of:
         C Currency in the Hands of the Public
       + R + Reserves of the Banking System
      =MB                    = Monetary Base



 • Monetary base is typically the monetary
 liabilities of the central bank.
Money Supply vs. Monetary Base



 Monetary       Money            Money
            *                =   Supply
 Base           Multiplier
           Balance Sheets
• Central banks like all banks have balance
  sheets with assets and liabilities.
• Hong Kong has some unique monetary
  institutions which may be most usefully
  examined in the contrast with US central
  bank (which is examined closely in the
  textbook).
Balance Sheets of U.S. Federal Reserve
 Liabilities
 Monetary Base
 Federal Reserve Notes                                719.4
 Deposits of Depository Institution                      24
 Nonbase Liabilities
 Deposts of U.S. Treasury                                5.9
 Other                                                  37.8

 Assets
 Foreign Currency Assets                               21.4
 US Government Securities                             725.6
 Discount Loan                                          0.4
 Other Assets                                          63.8

                        Billion US$, 12-2004, Federal Reserve
                        Annual Report
     Central Bank Balance Sheet
               Assets
• Government Securities: A large number of
  central banks (but not HK) hold domestic
  currency government bonds as main holdings of
  central bank.
  – These are used to conduct monetary policy
• Foreign Reserves: Central banks typically hold
  some foreign currency assets. Foreign reserves
  are also held by Treasury/Finance Ministry.
    Central Bank Balance Sheet
           Assets (cont.)
• Loans: Central banks also conduct
  monetary policy by lending reserves to
  banks.
• Miscellaneous:
  – Float: Checks in the process of the payment
    system.
  – Gold Reserves, Stocks Etc.
           Structure of Assets: HK
•
Interest Paid to                                                Land Fund
Fiscal Reserve                Exchange Fund Assets
                                                               (since 1999)




                   Backing Portfolio          Investment Portfolio
                      (Invested                    (Invested
                     for Liquidity)               for Return)



                                           Domestic       Foreign
                    US Treasuries          Equities      Securities
Foreign vs. Domestic Currency
            Assets
                                    HK: Exchange Fund: Assets
                                             HKD mn

  1000000


  900000


  800000


  700000


  600000


  500000


  400000


  300000


  200000


  100000


       0
            Sep-1999   Sep-2000              Sep-2001        Sep-2002                  Sep-2003   Sep-2004


                          Fo re ig n Curre ncy Assets   Ho ng Kon g Dol la r Asse ts
    Central Bank Balance Sheet
             Liabilities
• Deposits of the Government: Central Bank
  manages some of government wealth.
  – In 1997, holdings of the Land Fund were
    deposited with HKMA along with HK’s Fiscal
    Reserves.
      Central Bank Balance Sheet
          Monetary Liabilities

• Currency: Paper Money is typically issued by
  central bank. Coins are sometimes (as in HK)
     • Currency Held by Non Bank Public [C]
     • Currency Held by Banks aka “Vault Cash”:
       includes money ATM machines.
• Deposits of Banks: Banks keep accounts at the [R]
  central bank to facilitate payments and meet
  regulatory requirements.
    An average of 4.6% of currency in circulation in
    USA is vault cash. In HK, 7.5%
Balance Sheet of Exchange Fund
   Liabilities
   Monetary Base
   Certificates of Indebtedness                  146.8
   Coins & 10$ Bills                               6.4
   Balance of the Banking System                  15.8
   Exchange Fund Bills and Notes                 125.9
   NonBase Liabilities
   Placements by Government                      281.1
   Other Liabilities                             104.2
   Net Worth                                     428.9

   Assets
   Investments in Securities                     977.4
   Other Assets                                  137.4
                Billion HK$, 12-2004, HKMA Annual Report
        HK$ Money Categories
               Source: HKMA http://www.info.gov.hk


       Legal     Demand
tender notes     deposits
   and coins         with
    in hands     licensed
   of public        banks            M1

  145,852       207,444       353,297
                                    NCDs
   Savings           Time      issued by
   deposits       deposits       licensed
       with           with          banks
   licensed       licensed      and held
      banks          banks     by public             M2

  788,211      1,288,193        76,342      2,506,043
Hong Kong’s Unique Monetary
        Institutions
 “Guide to Hong Kong Monetary and Banking
            Terms” by HKMA.see
           http://www.hkma.gov.hk
                Currency
• Hong Kong’s central bank does not print money.
• Bank of China, HSBC, and Standard Chartered
  print banknotes but…
   – the banks can only issue paper notes if they
     buy licenses from the central bank with US$
     at a rate of $1 per HK$7.8 printed.
• The Licenses are called Certificates of
  Indebtedness Certificates issued by the
  Financial Secretary to be held by note-
  issuing banks as cover for the banknotes
  they issue.
• CI’s appear as liabilities on HKMA balance
  sheet.
   Certificates of Indebtedness
increase when currency increases
              HK: Monetary Base: Before Discount Window: Certificates of Indebtedness
                                             HKD mn

 140000

 135000

 130000

 125000

 120000

 115000

 110000

 105000

 100000

 95000

 90000

 85000

 80000
          7-Sep-1999                 19-Jan-2001                  3-Jun-2002            16-Oct-2003
                              Coins

   • Coins (and recent 10 Banknotes) are
     issued by the central bank unlike the
     USA where they are issued by the
     Treasury.




Definitions here are from the “Guide to Hong Kong Monetary and Banking
  Terms” by HKMA.see http://www.hkma.gov.hk
   Reserves: Clearing Balances
• The reserve requirement in HK is zero.
  Banks must only have enough reserves to
  meet all of their payment obligations.
• Clearing Account: The accounts
  maintained with the HKMA for settling inter-
  bank balances and payments between
  banks and the HKMA.
  – Aggregate Balances: The sum of balances
    maintained by banks in clearing accounts at the
    central bank.
Reserves: Exchange Fund Bills
• Exchange Fund Bills and Notes Debt
  Instruments issued by the HKMA for the
  account of the Exchange Fund.
• Since 1990, the Exchange Fund has sold
  short-term bonds (stretching the maturity
  structure as time goes on ).
• Exchange Fund bonds are listed on HKEX
  and traded in secondary markets.
Should government debt be part of
       the monetary base?
• Exchange Fund Paper can be held by anyone,
  but large share is owned by local banks.
  Therefore, they can be thought of as being
  mostly secondary reserves of banks.
• ExFund paper is held primarily for HK$ liquidity
  management purposes.
• These instruments are fully backed by Foreign
  Reserves. The HKMA has undertaken that new
  Exchange Fund paper will only be issued when
  there is an inflow of funds.
Hong Kong Exchange Fund Bills
          &Notes
                                         Exchange Fund Notes




              Nonbanks
HK$ Million




                Banks                                                                    Series1




                  Total



                          0   20000   40000   60000   80000   100000   120000   140000
 HKMA & Fed: Similarities & Differences
            Assets                Base
Same                              Central Bank
                                  Liabilities
Different   •Fed assets are       • HK liabilities
            primarily Treasury    include interest
            securities            paying tradable
            •HKMA assets are      securities primarily
            primarily foreign     held by banks
            currency securities   •Fed Liabilities
                                  don’t pay interest.
                                  Ex Fund bonds do.
    HKMA & Fed Similarities & Differences
            (Monetary Base)

            Currency             Reserve Accounts

Same        Large part of        Banks keep funds at
            monetary base.       central bank
Different   • Fed prints US      • US Reserve accounts
            currency             are required by
            •3 private banks     regulation.
            purchase licenses    •HK Clearing balances
            to print currency.   are only necessary for
                                 transactions.
Changing the Monetary Base
  4 Ways Central Banks Change
         Monetary Base
1. Open Market Operation – Sell/Purchase
   Government Securities
2. Discount Window – Bank borrows funds
   from Central Bank
3. Foreign Exchange Intervention
4. Printing Currency
               T-Accounts
• T-Accounts are a handy tool for examining
  the effects that any transaction has on
  balance sheets.
• A bank transaction will change both
  liabilities and assets (and possibly net
  worth). The total change in liabilities plus
  net worth must always equal the total
  change in assets.
              Open Market Purchase:
          The Fed Purchases $100 of T-Bills from Bank A


                            Fed Balance Sheet
• Fed credits the reserve
  accounts of Bank A which Assets             Liabilities
  increases its liabilities
  and takes possession of   +100 T-Bills      + 100 Reserves
  an equal value of
  securities as assets.

                                 Bank A Balance Sheet
• Bank A gets an extra            Assets                Liabilities
  amount of reserves and
                                  +100 Reserves
  loses an equal amount of
  securities.                     -100 T-Bills
              Exchange Rate
•   The exchange rate between any
    currency and the US dollar can be
    written in two ways.
    1. S: # of Currency Units per dollar (e.g.
       7.8HK$ per US$)
    2. Ex: # of Dollars per Currency Unit (e.g.
•   For most currencies (exceptions € & £),
    the former definition prevails.
           Currency Market Intervention
Central Bank buys 100/S foreign currency from Bank.
• Central Bank          Central Bank Balance Sheet
  credits Bank A
  reserves with 100      Assets                         Liabilities
  of domestic            +100 Foreign Reserves*         + 100 Reserves
  currency.
• This will increase
  Central Banks            *100/S when measured in foreign currency
  asset holdings of
                       Bank A Balance Sheet
  foreign reserves
  of 100/S.                Assets                        Liabilities
• Bank A has 100
  extra in reserve         +100 Reserves
  assets but loses         -100 Foreign Currency*
  100/S in foreign
  currency
          Discount Loans :
        The Fed Lends $100 to Bank A
                       Fed Balance Sheet


Reserves are         Assets            Liabilities
divided into         +100 Loan         + 100 Reserves
borrowed
reserves and
nonborrowed            Bank A Balance Sheet
reserves.             Assets               Liabilities
                      +100 Reserves        + 100 Loan
 Convertibility Undertaking: Currency
• Currency Board “When the three NIBs issue
  banknotes, they are required to submit US dollars
  (at HK$7.80=US$1) to the HKMA for the account of
  the Exchange Fund in return for Certificates of
  Indebtedness (which are required by law as
  backing for the banknotes issued).”

HKMA      A           L
+100 FC Reserves      +100 CI’s

      NIB       A            L
      +100 CI’s              -100 Deposit
      -100 FC Reserves       +100 Cash      2
      Clearing Accounts Reserves
• 1996-2005 The HKMA has an undertaking to
  convert Hong Kong dollars in clearing accounts
  into US dollars at rate of HK$7.8 to US$1
  – When the exchange rate depreciates to $7.8, the
    HKMA allows licensed banks to trade clearing
    balances for US dollars.

• May 2005 Under the strong-side Convertibility
  Undertaking, the HKMA undertakes to buy US
  dollars from licensed banks at 7.75. Under the
  weak-side Convertibility Undertaking, the HKMA
  undertakes to sell US dollars at 7.85.
   – Within the Convertibility Zone between 7.75 and 7.85,
     the HKMA may choose to conduct market operations
     ….
Convertibility        HKMA

Undertaking &         Assets           Liabilities
                       + 100 Foreign            + 100
                           Currency          Reserves
• Bank A converts        (US$12.82)
  US$12.82 into HK$
  reserves,
The Money Supply Process
     Fractional Reserve Banking
• Banks keep only a fraction of any deposits
  they receive on hand in the form of vault.
  The rest is used to acquire other assets,
  especially loans.
                             R
• Reserves- Deposit Ratio: D
The fraction of deposits kept as reserves is
  the Reserves-Deposit Ratio.
  – D = Demand Deposits (we can think of this as
    equivalent to checking accounts).
            Liquidity Portfolio
• Savers keep some of their asset portfolio in
  liquid assets.
• We can divide up liquid assets into currency and
  deposits                 C
• Currency-Deposit Ratio: D
  – Bank deposits and currency are both assets which
    will be part of the portfolios of savers.
     Monetary Base & Money Supply
• A given increase in the monetary base
  creates money on a greater than 1 for 1
  basis.
• Each $1 of reserves can be used to
  back up more than $1 of deposits which
  will exist as the stock of money.
• Money supply consists of currency in
  circulation plus some level of bank
  deposits.
                  M1 = C + D
OMO & Multiple Deposit Expansion
• The simplest way to see how fractional
  reserve banking causes multiple money
  expansion is to assume C D  0 .            .
• In our example, we will assume R D  .10.
     Central bank open market purchase
   increases Bank A’s reserves by $100K.
                           Bank A
1. Bank A increases                    Assets Liabilities
   reserves
2. Bank makes loan to           +100 Reserves
   real estate developer      1
   by crediting bank               -100 T-Bills
   account.                     2   +100 Loan + 100 Deposits
3. Developer writes a         3 -100 Reserves -100 Deposits
   check to pay a
   construction company
   for services.           Bank B
                            Assets              Liabilities

• Construction Company      +100 Reserves       +100 Deposits
  deposits check with
  Bank B
Money Circulates through fractional
        reserve banking
                             Bank B
• Bank B maintains 10% of
                               Assets           Liabilities
  new deposits as reserves.
• They loan 90 to a            +100 Reserves    +100 Deposits
  department store. Bank B
  puts 90 into the department +90 Loans         +90 Deposits
  stores checking account.
                                                -90 Deposits
• The department store writes -90 Reserves
  a check to a clothes
  manufacturer for inventory. Bank C
• The clothes manufacturer    Assets           Liabilities
  deposits the check at Bank
                              +90 Reserves     +90 Deposits
  C.
 • Bank C maintains 10% of new deposits as reserves. They loan
   81 to a car dealer. Bank C puts 81 into the car dealers checking
   account. The department store writes a check to a car
   manufacturer.
         Bank C

         Assets                  Liabilities
         +90 Reserves            +90 Deposits
         +81 Loans               +81 Demand Deposits
         -81 Reserves             -81 Demand Deposits




Bank D      Assets                   Liabilities
            +81 Reserves             +81 Demand Deposits
                                Bank D

Assets            Liabilities

+81 Reserves      + 81 Deposits
+72.90 Loans      +72.90 Deposits
-72.90 Reserves    -72.90 Deposits


                                Bank E

Assets            Liabilities
+72.90 Reserves   +72.90 Deposits
+65.61 Loans      +65.61 Deposits
-65.61 Reserves    -65.61 Deposits
         Reserves       Demand
                        Deposits
Bank B   10             100
Bank C   9              90
Bank D   8.1            81
Bank E   7.29           72.90
Bank F   65.61          65.61
Total    100            409.31

                 But the process continues…
   Deposit Expansion Multiplier
                    Figure 17.17: Multiple Deposit Creation
                              $100,000
                              Reserves                              $100,000
          Federal
          Federal                                                     Loan           Real Estate
                                                 Bank A
          Reserve
          Reserve                                                                    Developer
                             $100,000
                             Securities
                                                                                            $100,000
                                     $90,000                                                Payment
                                    Loan
                                                                     $100,000
                                                                      Deposit
          Bank C                                 Bank B                             Construction
      Retains $9,000 in                                                              Company
      Retains $9,000 in
          Reserves           $90,000            Retains $10,000
                                               Retains $10,000
         Reserves           Deposit                Reserves
                                                in in Reserves

$81,000                             $72,900
 Loan                                  Loan                                    $65,610
                                                                                Loan        and on
                          Bank D                            Bank E
    $81,000                                                                                 and on.
                    Retains $8,100 in                    Retains $7,290 in
    Deposit            Reserves           $72,900           Reserves
                                            Deposit
                        Assuming a 10 percent reserve requirement, banks hold
                   no excess reserves, and there are no changes its currency holdings.
                     Money Multiplier
• The change in the money supply is a
  multiple of the change in the base
               M  D       
                              1  1  R  1  R 2  1  R 3  .... BASE
                              
                              
                                       
                                        D        
                                                D         D       
                                                                   
                      1                 1
                             BASE  R BASE
                 1  (1  D )
                          R
                                        D



• If   R        .1 ,   the money multiplier is 10
           D
           Monetary Feedback
                                Central Bank
Reserves
            rd
                        Banks




                                 Borrower




                 Depositor
           Monetary Feedback
                                Central Bank
Reserves
            rd
                        Banks




                                 Borrower




                 Depositor
           Monetary Feedback
                                 Central Bank
Reserves
            rd
                        Banks




                                Borrower




                 Depositor
                M1 Multiplier
• In the more general case, the M1 multiplier can
  be derived by the ratio of M1 to the monetary
  base.
                                           C 1
                             M1 C  D        D
                                       
                              B    CR C R
                                           D     D

• As long as the reserve ratio is less than 1, the
  money multiplier is greater than 1.
• Multiplier is decreasing in reserve-deposit ratio
  and decreasing in cash-deposit ratio.
           Monetary Feedback

Reserves                        Central Bank
            rd
                        Banks




Cash
                                Borrower




                 Depositor
                M2 Multiplier


M 2 Multiplier 
           Savings Deposits " Small " Time Deposits
1 C                      
       D          D                     D
                     C R
                       D     D
    Determinants of Reserve Ratio
1. Regulatory Requirements – Some regulatory
   regimes have minimum reserve levels.
                     Reserve Ratio =
     Required Reserves Ratio + Excess Reserves Ratio
                     (R/D) = rr + ER/D
2. Market Interest Rates – If assets are held in the form
   of reserves, banks lose opportunity to get interest
   income. The greater is the interest rate, the less
   reserves held.
3. Volatility of Deposit Outflows – If deposit outflows are
   likely to be large, banks hold more reserves.
                20
                  05




                          2
                              4
                                  6
                                      8
                                          10
                                               12
                                                    14
                                                         16
                    .0
                20 1
                  05
                    .0
                20 3
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                    .0
                20 5
                  05
                    .0
                20 7
                  05
                    .0
                20 9
                  05
                    .1
                20 1
                  06
                    .0
                20 1
                  06
                    .0
                20 3
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                    .0
                20 5
                  06




M2 Multiplier
                    .0
                20 7
                  06
                    .0
                20 9
                  06
                    .1
                                                                   2005-2007




                20 1
                  07
                    .0
                20 1
                  07
Reserve Ratio       .0
                20 3
                  07
                    .0
                20 5
                                                              China Monetary Policy




                  07
                    .0
                20 7
                  07
                    .0
                20 9
                  07
                    .1
                      1
         Determinants of C/D
1. Wealth – Holding some cash is probably a
   necessity. Wealthier people hold less of their
   wealth in the form of cash.
2. Returns on Deposits – If the deposit interest rate
   is high, currency deposit ratio is small.
3. Risk – High default risk of bank deposits
   encourages cash holdings. Low crime risk
   encourages cash holdings.
4. Liquidity – Difficulty in using deposits in
   transactions encourages cash holdings.
5. Value of Anonymity Premium – High levels of
   black market activity/tax avoidance encourages
   cash holdings.
Japanese Banks face probability of
     default in recent years.

                                                               C/D: Japan

  0.12
 0.115
  0.11
 0.105
   0.1
 0.095
  0.09
 0.085
  0.08
 0.075
  0.07
         Jan-94

                  Jan-95

                           Jan-96

                                    Jan-97

                                             Jan-98

                                                      Jan-99

                                                                 Jan-00

                                                                          Jan-01

                                                                                   Jan-02

                                                                                            Jan-03

                                                                                                     Jan-04

                                                                                                              Jan-05

                                                                                                                       Jan-06

                                                                                                                                Jan-07
Money Multiplier and
 Monetary Policy
   Money as a Nominal Anchor
• One way to commit to a low inflation policy
  is to commit to low money growth a tenet
  of a school of macroeconomic analysis
  referred to as “monetarism”
• Timely reporting of the supply of money
  can help to build credibility for low inflation.
Problem: Central bank cannot control the
  money supply. Can only directly control
  the monetary base.
     US M2
                                                               M2 Multiplier
     Money
                           14
    Multiplier             13

•The history of            12

volatility of the M2       11
multiplier has
                           10
convinced the Fed
that it is impossible to   9

control the money          8
supply through their
                           7
control of the
                                Jan-59

                                         Jan-64

                                                  Jan-69

                                                           Jan-74

                                                                    Jan-79

                                                                             Jan-84

                                                                                      Jan-89

                                                                                               Jan-94

                                                                                                        Jan-99

                                                                                                                 Jan-04
monetary base.
                                                    M2 Multiplier

                   10
                   9.5
• Over the past     9

  8 years, the     8.5
                    8
  M2 multiplier    7.5
  has been          7
  more volatile    6.5

  in HK than the    6
                         Sep-98

                                  Sep-99

                                           Sep-00

                                                      Sep-01

                                                                    Sep-02

                                                                              Sep-03

                                                                                       Sep-04

                                                                                                Sep-05
  USA.
                                                               HK            USA
 Can the Central Bank Control the
         Money Multiplier
• The government’s main tool to control the
  multiplier is the required reserve ratio. However,
  this regulatory tool is less effective if banks
  reserve holdings exceed requirements.
• In other economies, such as the US and
  Euroland, the reserve requirement is low and the
  regulation seldom binds.
  – Technological change has allowed banks to evade
    reserve requirements.
• In many economies, including HK, Australia,
  Canada and the UK there is no reserve
  requirement.
 HK Dollar Peg: Fully Backed?
• The convertibility undertaking requires the
  HKMA to convert foreign currency into
  domestic currency at a rate of
  HK$7.8:US$1.
• Does the monetary authority have enough
  US dollars to meet this undertaking?
HK Foreign Currency Reserves vs.
       HK Money Supply

                                   Money and Reserves


                2500000


                2000000
  Million HK$




                1500000


                1000000


                500000


                     0
                          Base   FC Reserves    M1      M2   M3
                                               Aug-05

								
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