Expansionary Policy & Quantity Theory of Money (QTM)

Expansionary Policy & Quantity Theory of Money (QTM)
Expansionary policy means:
Increase in MONEY SUPPLY (M), and so AGGREGATE DEMAND (AD) rises

**Quantitative easing in US, Japan

For QTM:

MV = PY, whereas V is usally constant

M = Money Supply
V = Velocity of circulation of money
P = General Price Level
Y = Real Output
PY = Nominal Output
Yf = Potential output

Situation I: When DEFLATIONARY GAP occurs

If deflationary gap occurs, unemployment needs to be solved.
Ye < Yf, equilibrium output is less than potential output.
Increase in AD will lead to an increase in general price level, thus output (Y) will also increase.

Effect of expansionary monetary policy
Full employment occurs, potential output (Yf) obtained.

Apply quantity theory of money (QTM):
MV = PY (assume V is constant)
M increases, lead to rise in P and Y.
(% rise in M) -> (% rise in P) +  (rise in Y)
Growth rate in money supply = Inflation rate + Growth rate of real GDP or real output

Situation II: When deflationary gap DOES NOT occur

Suppose deflationary gap does not occur. So, full-employment happens.

Ye = Yf, the equilibrium output is equal to potential output.

In the short run, increase in M and AD will cause general price level and output to rise.

Original Ye = Yf. But money supply increases, so Ye rises above Yf. Ye > Yf

In the long run, when general price level rises, cost of production rises, shifting SRAS to left.

Short run aggregate supply (SRAS) decreases, and so output (Ye) falls back to potential output (Yf).

Hence, Ye = Yf. However, gerneral price level (P) will rise further more.

International Trade

Why international trade is inevitable?
為何全球貿易是必須的？

Some countries lack certain natural resources 缺乏資源 or suitable climates 氣候不宜 for production of certain goods.

For countries which are not self-sufficient自給自足, they must rely on other countries through trade.

Even if two countries may be self-sufficient, sometimes they find producing particular goods costs them less. 考慮成本問題 They will then specialize in the production with lower cost and then exchange with other country to get the goods not produced. 降低成本 進行交易 以達至雙贏局面 The result will be a higher consumption of both goods for both countries.

Their benefits are due to the greater combined output after SPECIALISATION.

**FAQ

To determine whom specialises in what to be produced, and method to devide labour, we should concern about “absolute advantage”絕對優勢.

Countries considered to be have absolute advantage on a particular good refers to those countries which has higher productivity 高生產力 or output per unit of resources used. 在有限資源裏有較高產量

We have to also consider the opportunity cost.

Open market operations 公開巿場操作

Tools to control money supply (3)
控制貨幣供應方案（三）
Open Market Operations (OMO) 公開巿場操作

#Definition: Open market operations refer to the central bank's purchase and sale of government bonds in the market.
( = buying and selling of government bonds)

Situation I: 
Government buys bonds
政府買入債券
a) Release money (currency) to public
貨幣流入公眾
b) Part of the money is deposited into banks
部分現金會存入銀行
c) Multiple creation of credit
貨幣創造倍增
d) Money supply increases
貨幣供應增多

Paragraph in complete sentences:
When the central bank buys government bonds from the market,currency flows from the central bank to the market. Hence, the monetary base increases. Part of the currency is held by the public and part of it is deposited into banks. When banks lend their excess reserves to earn profits, multiple creation of money results. Thus, money supply increases further.

Situation II: 
Government sells bonds
政府售出債券
a) Absorb money (currency) from public
貨幣從公眾流走
b) Part of the money is withdrawn from deposits (banks)
部分現金會由銀行提出
c) Multiple contraction of credit
貨幣創造收縮
d) Money supply decreases
貨幣供應減少

Paragraph in complete sentences:
When the central bank sells government bonds from the market,currency flows from the market to the central bank. Hence, the monetary base decreases. Part of the currency taken is held by the public and part of it is withdrawn from banks. Multiple contraction of money results. Thus, money supply decreases.

SUMMARY

When the central bank buys (sells) the government bonds in the market, the money supply increases (decreases).
政府賣出債券 貨幣供應減

Required reserve ratio 儲備率

Tools to control money supply (2)
控制貨幣供應方案（二）
Required Reserve Ratio 儲備率

#Definition: The required reserve ratio is the minimum fraction of deposits that banks are required to keep as reserves.

Situation I: 
When required reserves decreases...
當儲備率減少
a) *Multiplier increases
倍數增大 (*Multiplier = reciprocal of RR)
b) Banks keep less required reserves
銀行需要的儲備減少
c)Excess reserves increases for loans
多餘的儲備可以用作貸款
d) Money supply increases
貨幣供應增多

Paragraph in complete sentences:
When the central bank lowers the required reserve ratio, banks need to keep less required reserves. So they have more excess reserves to loan out for profits. This results in multiple creation of money. Hence, money supply increases.

Situation II: 
When required reserves increases...
當儲備率增高
a) *Multiplier decreases
倍數減少 (*Multiplier = reciprocal of RR)
b) Banks keep more required reserves
銀行需要的儲備增多
c)Excess reserves decreases for loans
可用作貸款的儲備減少
d) Money supply decreases
貨幣供應大減

Paragraph in complete sentences:
When the central bank raises the required reserve ratio, banks need to keep more required reserves. So they have less excess reserves to loan out for profits. Multiple creation of money cannot be resulted. Hence, money supply decreases.

SUMMARY

When the central bank lowers (raises) the required reserve ratio, the money supply increases (decreases).
儲備率升 貨幣供應減

Discount rate 貼現率

Tools to control money supply (1)
控制貨幣供應方案（一）
Discount Rate 貼現率
**Discount rate唔係指購物時享有嘅折扣優惠(not equal to purchasing discount)**
#Definition: The discount rate is the interest rate that the CENTRAL BANK charges when it lends money to (private) banks.

Situation I:
When discount rate increases...
當貼現率增大
a) Cost of borrowing increases
銀行借錢代價增大了
b) Borrowing of cash from banks discouraged
銀行向中央銀行借錢意欲大減
c) Reserves CANNOT be raised to facilitate more lending
儲備不足供應巿民貸款
d) Money supply drops
貨幣供應大減
Paragraph in complete sentences:
When the central bank raises the discount rate, the cost of borrowing from the central bank increase. Banks will borrow less from the central bank. Thus, reserves cannot be raised to facilitate more lending. Money supply drops.

Situation II:
When discount rate decreases...
當貼現率減少
a) Cost of borrowing increases
銀行借錢代價減少了
b) Borrowing of cash from banks discouraged
銀行向中央銀行借錢意欲大增
c) Reserves are ABLE to loan out money to earn profits
儲備足以供應巿民貸款
d) Money supply increases
貨幣供應大增
Paragraph in complete sentences:
When the central bank lowers the discount rate, the cost of borrowing from the central bank drops. Banks will borrow more from the central bank and then loan out the money to earn profits. Money supply increases.

SUMMARY

When the central bank lowers (raises) the discount rate, the money supply increases (decreases).
貼現率升 貨幣供應減