Monetary Policy

1. What Is Monetary Policy?

Measures issued by the central bank to adjust money supply or credit conditions.

1.1. Money-Supply and Money-Demand Balance

1.1.1. Money Supply

M=m*B, where M is the money supply, m is the money multiplier, and B is the monetary base.

1.1.2. Money Demand

2. Classification of Monetary Policy

2.1. Interest-Rate Policy

Lowering commercial-bank deposit and lending rates can encourage people to spend rather than save and can encourage firms to borrow and invest.

2.1.1. Tools

Expansion: lower interest rates, leading to an increase in B -> increase in M. Contraction: raise interest rates, leading to a decrease in B -> decrease in M.

2.1.1.1. Adjust Central-Bank Policy Rates

2.1.1.1.1. Relending Rate

The rate used when the central bank lends to commercial banks.

2.1.1.1.2. Rediscount Rate

The rate applied when a commercial bank takes an unmatured bill to the central bank and converts it to cash.

2.1.1.1.3. Required-Reserve Interest Rate

The interest rate the central bank pays commercial banks on required reserves.

2.1.1.1.4. Excess-Reserve Interest Rate

The interest rate the central bank pays commercial banks on reserves held above the required-reserve level.

2.1.1.2. Adjust Statutory Deposit and Lending Rates of Financial Institutions

2.2. Exchange-Rate Policy

Lowering the exchange value of the domestic currency can support exports.

2.2.1. Tools

2.2.1.1. Exchange-Rate Regime

Floating exchange rate. Fixed exchange rate.

Why Didn’t U.S. Stocks Keep Falling When the Federal Reserve Raised Rates?

Why did U.S. stocks rise after Fed rate hikes? - Zhihu The Federal Reserve raised rates to address inflation. Stocks did fall during parts of the tightening cycle and later recovered. How do Fed rate hikes affect global wealth? - Zhihu Transmission through interest rates -> bond market + stock market + exchange rates.

2.2.1.2. Foreign-Exchange Market

Establish foreign-exchange stabilization funds or similar mechanisms.

2.2.1.3. Foreign-Exchange Operations

Foreign-exchange transactions may be handled through designated state foreign-exchange authorities or banks.

2.3. Credit Policy

3. Common Monetary-Policy Tools

3.1. Reserve Requirements

Raising the reserve-requirement ratio reduces m and therefore reduces M in the simplified multiplier framework.

3.2. Rediscount Policy

Discounting: the public takes an unmatured bill to a commercial bank and converts it to cash. Rediscounting: a commercial bank takes an unmatured bill to the central bank and converts it to cash. This differs from repo and reverse-repo transactions in Bonds. Raising the rediscount rate reduces B in the simplified framework and therefore reduces M.

3.3. Open-Market Operations

The central bank buys and sells securities and, in some frameworks, foreign-exchange assets in the market. Selling securities or foreign exchange withdraws base money and reduces B in the simplified framework.

3.4. LPR (Loan Prime Rate)

MLF (Medium-term Lending Facility)

MLF, the Medium-term Lending Facility, was introduced by the People’s Bank of China in September 2014. The market nickname in Chinese is “malafen.” In simple terms, it is a monetary-policy tool through which the central bank provides medium-term base money to eligible commercial and policy banks. The current MLF operation term is one year. What Is MLF (“Malafen”) and What Does It Affect? - Shangguan News

4. M0, M1, and M2

Understanding M0, M1, and M2 - Zhihu

4.1. What They Are

M0 is cash, roughly the money in your wallet. M1 is M0 + corporate demand deposits + personal demand deposits + customer reserve funds held by non-bank payment institutions, reflecting immediately spendable purchasing power. M2 = M1 + corporate and personal time deposits + other deposits, reflecting a broader measure of money.

4.2. Use

M2 is an important measure of broad money. Money growth can affect asset prices through credit, interest-rate, and portfolio-allocation channels, but M2 growth by itself does not imply that housing or stock prices must rise.

4.3. M1-M2 Gap

1. If M1 growth > M2 growth, narrow money is growing faster. This can be one clue that funds are becoming more transaction-oriented and trading activity is strengthening, but it cannot by itself establish corporate profitability or the direction of the economy.
2. If M1 growth < M2 growth, time and other deposits within broad money are growing relatively faster. This can be one clue that funds are becoming less transaction-oriented, but it likewise cannot by itself establish profitability or an economic downturn.

5. References

Monetary Policy - Baidu Baike Foreign Exchange Policy - Baidu Baike PBOC Monetary Policy Reports 2023 Q1 Monetary Policy Report - Bilibili Interpreting the Central Bank Monetary Policy Implementation Report - Zhihu Reserve Requirement Ratio Data - Eastmoney Money Supply / Macro Data / M1-M2 Gap - Haipitudou What Is the M1-M2 Gap and Why Watch It? China M1-M2 Gap - MacroMicro