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Monetary policy QE and other tools

19 important questions on Monetary policy QE and other tools

What is the prime objective of the monetary central bank?

Creating price stability (Keep inflation at just below the target level of 2 %. Why not aim for 0%. To have some margin. But there are now discussions going on whether there should be a range instead of a strict target. The focus of monetary policy is on the demand side of the economy, not the supply side. Decrease interest rates: decrease savings, increase consumer spending, increase economic growth, increase rate of investment
Increase interest rates: Increase savings, withdrawal money from circular flow. Slows economic growth. Decreases rate of investment in capital assets.

What is the money multiplier effect? Did it perform during the crisis?

The expansion of a country's money supply that results from banks being able to lend. The size of the multiplier effect depends on the percentage of deposits that banks are required to hold as reserves. In other words, it is money used to create more money and is calculated by dividing total bank deposits by the reserve requirement.


M1 = (1+c) / (rr +er + c) * M0


c = currency
rr = required reserves
er = excess reserves

Explain how the monetary framework works (instruments, operational target, intermediate target, ultimate target)

  1. Instruments (policy rate, asset purchases)
  2. Operational target (money market interest rate, central bank reserves)
  3. Intermediate target (monetary aggregate (M3), exchange rate, inflation estimates --> these are partially driven by externalities
  4. Ultimate goal --> price stability (inflation ( gdp growth, financial stability)
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How do the mandates of central banks differ?

  • FED in the US has a dual mandate (Price stability (inflation target) & economic target (employment) This dual mandate may create tension
  • The ECB only has a single mandate for price stability (Inflation)
  • The bank of England has an inflation target ( also use the exchange rate )
  • Small countries (Denmark) but also China have an Exchange rate target (peg to anchor currency). To import stability form the euro area in case of Denmark and dollar in case of China.

What is the difference between Core Inflation and HICP. Where should the ECB focus on?

  • HICP is the Harmonised Index Consumer Prices, or headline inflation)
  • Core inflation excludes raw food and commodity prices.


The HICP is easy to explain to the public. For instance the 60% of the drop in HICP is cause by the drop in oil prices. The public can understand this. The core inflation is more stable put harder to interpreted. Core inflation can be misleading for consumers, who will mistrust figures which exclude many prices they have to pay for.

What are the differences in forward guidance in monetary policy?

  1. Open-ended guidance (no particular date)
  2. Time-contingent guidance (particular date)
  3. State contingent, threshold guidance (as long as unemployment is lower than x %) --> now more a range of indicators instead of just employment
  4. Qualitative guidance ( one based on number of economic thresholds)

What has been the effect on the yield curve of recent economic monetary policy in the Euro area and the US?

  • Yield curve flattened in the Euro area
  • The Euro rate decoupled from the US rates. Where US rates are expected to grow, the euro rates are still flat.

What is the difference between a corridor monetary policy and a floor system? What do we have nowadays?

A corridor system has un upper boundary (central banks lending rate) and a floor (central banks deposit rate). In the middel is the key policy rate. By providing full liquidity to banks the rate is always at the floor. Why would banks lend at lower higher rate then for which they can lend it out to the CB. Thus the liquidating the banks in such a matter creates a floor system

The Euro area follows a two pillar influence strategy. Explain how that works.

  1. The monetary policy strategy looks at two sets of indicators: the economic indicators (output and components, demand, labor market conditions, etc. ) and the monetary indicators (finacials such as money based inflation indicators, liquidity measures, etc.)
  2. They proces this information. The different indicators are used to model future projections.
  3. The projection are analysed based on the same indicators: 1. Economic analysis (assessment short&medium term determinants inflation) 2. Monetary analysis (monetary trends with the focus on long term)
  4. Governing council makes the monetary policy decision aimed at influencing price stability

What is the reaction of the ECB  to the crisis with regard to the money marker)

  • Narrow corridor (reduce the volatility)
  • Supply massive liquidity
  • Drop the intrest rate to the floor (lending rate to the ECB)

The effect of the liquidity supply is was that in 6 months the money market rates dropt severly

What is the reaction of the ECB to the failing money multiplier ?

An asset purchasing program. By buying put the assets (securities and bonds) of non-banks they try create liquidity for these companies which positively should influence the economy.

Are QE programs effective?

No consensus in research

What makes the transmission mechanism from policy rates to prices so complex?

The enormous amounts of factors that come into play. Policy rates influence bank and market rates, expectations and the exchange rate, asset prices etc. These influence demand and supply, and we can go on for a while. Eventually they will impact price developments

What does the fragmentation of the euro area loan rates mean?

Its a sign that there are problems in the EURO area, banks ask for a risk premium differently in each country. This makes it hard for the ECB to influence the economies.

What is unconventional monetary policy?

  • Credit easing (2007 - 2014)
  • - Liquidity & Funding risk (longer-term refinancing operations, extension of collateral risk (.i.e. banks could borrow with weaker collateral)
  • - Credit supply banks (Very long Term Refinancing Operations VLTROs)
  • - functioning of bond markets (securities market program (SMT) and outright monetary transactions (OMT))
  • Quantitative easing (2015-2016)
  • - Expanded asset purchasing programme (CB, ABS, government bonds)

What is the expectations channel of QE?

In expectation of the QE program of the ECB the Bond Yields has dropped and the Euro/dollar Exchange rate has weakened. 

What have researchers calculated the impact of QE on bond yields to be in the US?

The impact of Large scale asset purchases on long term interest rates is calculated to be a decrease of 41 basis points.

Through which channels did QE have an effect?

Not trough the bank lending channel, it did however expand the money supply (create liquidity). It should have an effect on inflation (raise the inflation level) and research has show a marginal increase. Also there is an effect on the US economy by increasing the GDP levels.

What is the DNB policy stance toward QE?

  • Strong medicine, uncertain outcome
  • There are challenging risks: (negative side effects, communication, moral hazard)
  • All monetary policy should have the following conditions (Termporary, Credible, within the euro system)

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Financial Markets and institutions

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