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Three main tactical approaches to maintain monetary stability
by 趙永祥 2015-03-18 00:00:32, 回應(0), 人氣(1398)

         Three main tactical approaches to maintain monetary stability

                                            By Dr. Chao Yuang Shiang


Monetary policy uses three main tactical approaches to maintain monetary stability:

  • Money supply. The first tactic manages the money supply. This mainly involves buying government bonds (expanding the money supply) or selling them (contracting the money supply). In the Federal Reserve System, these are known as open market operations, because the central bank buys and sells government bonds in public markets. Most of the government bonds bought and sold through open market operations are short-term government bonds bought and sold from Federal Reserve System member banks and from large financial institutions. When the central bank disburses or collects payment for these bonds, it alters the amount of money in the economy while simultaneously affecting the price (and thereby the yield) of short-term government bonds. The change in the amount of money in the economy in turn affects interbank interest rates.

  • Money demand. The second tactic manages money demand. Demand for money, like demand for most things, is sensitive to price. For money, the price is the interest rates charged to borrowers. Setting banking-system lending or interest rates (such as the US overnight bank lending rate, the federal funds discount Rate, and the London Interbank Offer Rate, or Libor) in order to manage money demand is a major tool used by central banks. Ordinarily, a central bank conducts monetary policy by raising or lowering its interest rate target for the interbank interest rate. If the nominal interest rate is at or very near zero, the central bank cannot lower it further. Such a situation, called a liquidity trap,can occur, for example, during deflation or when inflation is very low.

  • Banking risk. The third tactic involves managing risk within the banking system. Banking systems use fractional reserve banking to encourage the use of money for investment and expanding economic activity. Banks must keep banking reserves on hand to handle actual cash needs, but they can lend an amount equal to several times their actual reserves. The money lent out by banks increases the money supply, and too much money (whether lent or printed) will lead to inflation. Central banks manage systemic risks by maintaining a balance between expansionary economic activity through bank lending and control of inflation through reserve requirements.

These three approaches -- open-market activities, setting banking-system lending or interest rates, and setting banking-system reserve requirements to manage systemic risk -- are the "normal" methods used by central banks to ensure an adequate money supply to sustain and expand an economy and to manage or limit the effects of recessions and inflation. 

These "standard" supply, demand, and risk management tools keep market interest rates and inflation at specified target values by balancing the banking system's supply of money against the demands of the aggregate market.