Flashcards in roles of government Deck (48)
What are the 4 economic goals for any modern economy?
• avoid too much inflation
• achieve full employment
• achieve sustainable economic growth-economic prosperity
• achieve a stable currency & strong international payments
do banks need capital reserves to operate?
yes the reserves are set by law or convention
it is concerned with control of amount of money in circulation i.e. money supply & its growth
what is the purpose of monetary policy and how does it try to achieve this?
• Used (along with fiscal policy) to prevent wide swings from high peaks to low troughs in business cycles
• Monetary policy - directed at influencing level of interest rates
by targeting a base cash rate
• MP to try to stimulate economy - reduce interest rates
• Reducing interest rates should lead to better economic growth
• MP to try to slow down economic growth - increase interest
Relationship between Central Banks and
1. A Govt sets monetary policy & central bank implements it.
Case in NZ up to 1986.
2. A Govt sets monetary objectives within certain constraints -
central bank free to achieve objectives. Case in NZ now.
3. Monetary policy objective set in legislation - central bank free
to follow whatever course of action it sees fit to achieve
Case in Euro area & Switzerland.
what is NZ monetary policy objective?
objective under 1989 RB Act: to control inflation &
keep in band (stable prices)
who has to agree on a Policy target agreement?
Treasurer & Governor
what does OCR stand for?
Official Cash Rate
What rate does the RBNZ target?
The official cash rate (OCR)
Who controls the currency?
The RBNZ control the currency and sells (issues) cash to the banks that need it
what does RBNZ stand for?
Reserve bank of NZ
How many times a year is the OCR reviewed?
8 times a year & changes 25 bp or multiple.
what rate does the reserve bank (RB) borrow & lend at?
borrows and lends at OCR
WHAT RATE IS USED IF BANKS WANT CASH OVER NIGHT?
banks are charged interest rate 0. 50% above OCR
what is reverse repurchase agreement?
purchase of securities
with the agreement to sell them at a higher price at a
specific future date. (RBNZ)
• For the party selling the security (& agreeing to buy it
back in future-bank) it is a repo; for the party on the other
end of the transaction (buying the security & agreeing to
sell in the future) it is a reverse repurchase agreement
what are the Transmission Channels for monetary policy?
- Monetary policy channel
-Foreign exchange channel
Monetary policy channel
- increase in OCR by RBNZ
(This is a tool of monetary policy)
Then increase in other S/T rates as price of money bid up,
usually firstly S/T money market securities rates increase
e.g. bank-accepted bills- large company borrowing.
Then costs of funds for banks so they increase deposit rates
- increase in OCR rise in investment risk
bank lending may fall as borrowers come under stress due to
higher interest costs so less credit available
- higher interest rates decrease in asset
values loss of confidence for companies & households
decrease in economic activity
Foreign exchange channel
- rise in OCR higher exchange rate
exports may fall due to higher cost whereas import prices fall
harmful effect on balance of trade & economic output
what are the immediate effect of Monetary policy channel?
• Short term interest rates e.g. overnight rates
• Wholesale S/T interest rates
• Foreign exchange rates
what are the intermediate economic indicators Transmission Channels for monetary policy?
• money/credit- e.g. deposit rates, floating mortgage rates
• asset prices- bond and equity
• economic activity
• domestic demand
what is fiscal policy and what are the instruments of it?
• Fiscal policy is concerned with govt.’s income & spending
• Tools (Instruments of fiscal policy) are:
– government spending or outlays &
– transfer payments
what is a budget deficit?
where government spending > income (from
taxes & other sources e.g. interest, fees & fines)
(1) what options can a govt use if its in a recession and wants to stimulate an economy but has a budget deficit?
one option is to borrow so its expenditure (G)
• Borrowing from the domestic market
• Borrowing funds from overseas markets
the other option is govt. can reduce taxes to stimulate the economy
(1) • Borrowing from the domestic market
central bank issues $100m govt bonds to borrow.
- If govt spends all funds
no change in money supply.
Increase in real gross domestic product (GDP) in short-run
If one-off borrowing, first, upward pressure on ST interest rates
(1) • Borrowing funds from overseas markets
- initially, no impact on local borrowing, then either inflationary
or growth creating (
in govt expenditure
increase in real
gross domestic product (GDP) in S/T, & likely an increase in
- Long term
the govt. debt has to be repaid with interest
contractionary impact on economic growth in L/T.
(1) reduce taxes to stimulate the economy
expansionary fiscal policy- consumers have more disposable income & in short-run, stimulatory fiscal policy will increase real GDP
Contractionary fiscal policy in regards to budget deficit
it could cut its
expenditure (spending) (G) overall
.- or raise taxes people will consume less as their net
disposable income drops
- or reduce transfer payments- targeted groups spend less