Demand Functions An algebraic equation representing demand as a function of the price plus consumer income levels and other factors Example: Linear: Q D = a – b × P Exponential: Q D = A × P -b
A demand curve is classified as INELASTIC if the elasticity is between 0 and 1 A demand curve is classified as ELASTIC if the elasticity is greater than 1 Unit elasticity (elasticity equal to 1) is the cutoff point
Monetary Policy & Exchange Rates The central impact of the foreign currency intervention is on domestic interest rates. Monetary policy that shifts domestic interest rates will also shift exchange rates regardless of whether it occurs through currency intervention, OMO, or some other change in quantity of bank reserves. Monetary policy that does not shift interest rates will not shift exchange rates.
Notes on Price Indices: Quality Some categories of goods (computers, cars) observe marked changes in quality over time. Price growth rates for these components often reflect the price growth for certain characteristics (e.g. MHz,GB HD, etc.). These are referred to as hedonic price indices.
Problem You are a Chinese multinational that wants to construct salaries to be paid to employees in Canada that will provide same living standard as salary of RMB20,000. Canada PPP in 2005 is 1.21.
Some (Anglophone) developed countries have high job separation rates but high job finding rates. Developed Asian markets typically have lower job separation rates and lower natural unemployment. Unemployment Dynamics in the OECD, 2008 Michael Elsby, Bart Hobijn, Aysegul Sahin http://www.nber.org/papers/w14617 http://www.nber.org/papers/w14617 Continental countries have low job separation rates but very low job finding rates.
P Y AS t Dynamic AS-AD Model: Trend Path AD t Yt*Yt* YtPYtP Y P t+1 AD t+1 AS t+1 Y* t+1 Pt*Pt* P* t+1 Demand expansion matches supply expansion Average Inflation Ch. 29, 711-712
Chapter 25, 31 Money, Central Banking, and Inflation
Evolution of Money In more advanced societies with sophisticated banking systems, broad money may be used for transactions. Currency: Paper assets issued by central bank Checking Accounts: Paper promises to pay definitive money on demand. Savings Accounts: Electronic Transfers, Credit Cards, Debit Cards and ATM Cards can be used to transfer funds to.
Money Supply Multiplier The money multiplier can be derived by the ratio of aggregate money to the monetary base. 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.
Open Market Operations In an Open Market PURCHASE, the central bank purchases government securities from banks and credits their reserve accounts. This increases the aggregate supply of reserves. In an Open Market SALE, the central bank sells government securities from banks and debits their reserve accounts. This reduces the aggregate supply of reserves.
Government Surplus Government surplus is gap between govt revenue and spending and can be positive or negative. If net positive, it adds to the supply of loanable funds. If net negative, it adds to the demand for loanable funds.
Consumers become less thrifty (r does not fall, gap made up by capital inflows) LF rWrW r 1 2 KA D LF S LF S LF '
Central Bank Policy Makers reduce interest target- Open Market Purchase S D'D' i IBR Reserve Accounts i TGT ' 1 S'S' 2 D i TGT
Open Market Practice On a daily basis, a central bank will provide instructions to engage in defensive transactions that will adjust supply to keep the interbank interest rate near the target rate. Example: If there is an excess demand for reserves, the traders might engage in an open market purchase of bills, increasing the supply of reserves pushing down the rate until it is near the target.
P Y AD An Expansionary Cycle Driven by monetary policy P*P* SRAS YPYP AD ′ 1 2 Output Gap 1.Economy at LT Y P. 2.Monetary Policy Cuts Interest Rate 3.Expenditure rises. The AD curve shifts out. 4.Tight labor markets. SRAS returns to long run equilibrium 3
Interest Rate Management In most economies around the world, the central bank does not simply act to maintain a fixed interest rate. Rather, they manage interest rate changes in response to business cycle conditions.
List of Inflation Targeting Countries Rose A Stable International Monetary System Emerges: Inflation Targeting is Bretton Woods, Reversed Rose
HKMA LinkLink KEY GOAL OF CENTRAL BANKS: PRICE STABILITY
Policy Feedback: Taylor Principle Real interest rate impacts demand for goods in economy. Real interest rate is r t = i t - E[π t+1 ] When E[π t+1 ] rises, central bank should increase i t more than 1-for-1 to raise real interest rate, limit demand and limit inflation. When E[π t+1 ] falls, central bank should reduce i t more than 1-for-1 to drop real interest rate, raise demand and avoid deflation.
Learning Outcomes Use the model of bank reserves and the forex market to describe the effect of Hong Kong’s monetary policy. Use the model of the bank reserves market to qualitatively derive and describe the impact of defensive and dynamic transactions on interbank rate and quantity of reserves. Use the model of the money market and AS-AD to qualitatively derive and describe the impact of monetary policy transactions on the economy. Use the Taylor rule to quantitatively describe the impact of economic conditions