FPP.

1X  –  MONETARY  AND  
In  so  doing,  we  say  that  the  financial  sector  serves  as  a  bridge  
among  different  sectors  of  the  economy.  Households  typically  
generate  savings,  while  the  corporate  sector  typically  requires  
FINANCIAL  ACCOUNTS financing  for  their  investments.  The  role  of  the  financial  sector  is  to  
collect  savings  from  the  households  sector  and  provide  financing  to  
  the  corporate  sector.  
  By  converse,  it  collects  the  cash  balances  from  the  corporations  
VIDEO  1:  Introduction   and  provides  loans,  such  as  mortgages,  to  households.  How  does  
  the  financial  sector  provide  these  services?  Financial  institutions  can  
Hello.  My  name  is  Luisa  Zanforlin.  I  am  a  Senior  Economist  in  the   provide  special  instruments.  Among  the  main  instruments  there  are  
Institute  for  Capacity  Development  of  International  Monetary  Fund.   savings  vehicles.  
   
My  role  is  to  guide  you  through  the  function  and  activity  of  the   They  allow  people  to  safely  store  away  their  earnings  and  enjoy  
Monetary  and  Financial  sector,  and  the  ways  these  are  reported  in   them  at  a  later  date.  Savings  vehicles  are  the  instruments  through  
the  accounts  of  the  Monetary  and  Financial  Sector.   which  the  public  can  smooth  consumption  through  time  and  
  therefore  achieve  a  higher  level  of  welfare  through  their  lifetime.  
Finally,  we  will  review  some  of  the  issues  confronting   The  financial  sector  also  creates  credit  instruments.  
the  decisions  on  monetary  policy.    
  These  allow  the  efficient  allocation  of  resources  to  investment  
Let's  first  try  to  understand,  what  are  the  main  functions   activities.  
of  the  financial  sector  and  how  it  operates?   Savings  are  collected  from  the  general  public  and  allocated  to  
  projects  of  low  risk  and  high  expected  returns.  
One  important  function  of  the  financial  sector  is  to  intermediate  the   The  financial  sector  also  provides  diversified  financial  instruments  
financial  flows  across  the  different  sectors.  It  provides  the  means   that  mitigate  the  income  loss  arising  from  unexpected  shocks  and,  
through  which  payments  can  take  place.   therefore,  provides  the  means  of  smoothing  income  and  
  consumption  over  time.  
Another  very  important  function  of  the  financial  sector  is  to  collect    
savings  generated  by  income  surpluses  in  some  sectors,  and  then   Monetary  and  financial  sectors  statistics  provide  information  on  the  
allocate  them  to  sectors  that  require  financing.   balance  sheets  of  the  different  types  of  financial  intermediaries—
 
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and  therefore,  of  the  different  financial  instruments  that  are   This  lecture  will  cover  two  main  themes.  
intermediated  in  the  economy  .    
  In  the  first  part,  we  will  review  the  structure  of  monetary  and  
These  statistics  are  compiled  according  to  the  different  functions   financial  statistics,  the  different  groups  of  financial  intermediaries,  
of  financial  intermediaries  and  different  activities.   and  how  different  operations  are  reflected  in  the  accounts.  First,  
The  financial  sector  is  defined  to  be  the  group  of  agents  of  the   we'll  take  a  look  at  the  different  types  of  financial  intermediary  
domestic  economy  that  intermediates  financial  resources.   composing  the  financial  sector  and  how  they're  grouped  together.  
   
As  there  are  many  different  ways  of  combining  statistics,  it  is   Then,  we  will  analyze  two-­‐sub  components—namely,  the  Central  
important  to  note  that  this  presentation  will  follow  the  guidelines  of   Bank  and  the  other  depository  corporations.  We  will  see  how  these  
the  Manual  of  Monetary  and  Financial  Statistics  of  2001.   two  groups  come  to  define  a  sub-­‐sector  of  intermediaries  called  the  
  depository  corporations  sector.  This  is  particularly  important  for  our  
Why  are  monetary  and  financial  sector  accounts  so  important?   analyses  because,  in  many  countries,  this  is  the  largest  sub-­‐sector  
The  monetary  and  financial  statistics  record  the  net  position   among  financial  intermediaries.  We  will  then  discuss  how  the  
of  the  financial  sector,  vis  a  vis  the  other  sectors  of  the  economy.   depositary  corporations  account  are  linked  to  the  other  accounts  
Therefore,  they  will  reveal  whether  the  sectors  have  been  net   that  you  have  been  seeing  in  the  other  lectures  so  far.  
savers  or  net  users  or  financial  resources.    
  In  the  second  part  of  this  lecture,  we  will  discuss  how  financial  
In  addition,  the  monetary  accounts  are  generally  available  with  little   intermediaries  create  and  multiply  the  amount  of  money  circulating  
delay  in  most  countries.  Even  where  reliable  economic  data  can  be   in  the  system.  We  will  then  discuss  the  main  reasons  why  people  
scarce,  they  are  among  the  most  reliable  of  the  macroeconomic   demand  to  hold  money  and  why  the  stock  of  money  in  the  economy  
statistics  and  therefore  useful  to  policymakers  who  need  to  monitor   is  an  important  variable  for  monetary  policy  decisions.  
economic  developments.    
  To  conclude,  we  will  review  some  selected  issues  
Why  is  the  role  of  the  monetary  accounts  so  important?   in  monetary  policy  analysis.  
   
Monetary  accounts  focus  on  variables  such  as  money,  credit,   The  main  objectives  of  this  class  are  to:  (1)  identify  the  main  
foreign  assets,  and  liabilities  that  play  a  central  role  in  the   institutions  composing  the  financial  corporations  sector;  (2)  to  
macroeconomic  analysis  of  an  open  economy,  and  are  particularly   understand  the  main  items  in  the  balance  sheets  of  the  depository  
useful  for  the  design  of  monetary  policy.   corporations  sector  and  the  consolidation  process;  (3)  to  analyze  
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how  money  is  created  and  calculate  the  growth  in  the  money   taking  corporations  as  "banks,"  but  the  actual  category  includes  a  
supply;  and  finally,  (4)  to  identify  the  main  determinants  of  the   much  broader  set  of  intermediaries,  such  as  cooperatives,  credit  
demand  for  money.   unions,  merchant  banks,  etc.  
   
  More  specifically,  the  two  categories  are  divided  in  other  
subcategories,  containing  at  least  one  financial  intermediary  
VIDEO  2:  The  Financial  Sector  
that  is  somehow  different  from  those  contained  in  the  other  
 
subcategories.  
Financial  Sector  Overview.  
 
In  this  section,  we  will  review  the  different  types  of  financial  
In  particular,  the  depository  corporations  sector  contains  the  central  
intermediaries,  the  main  characteristics  and  how  statistics  are  
bank,  or  a  currency  board  or  a  public  entity  with  central  banking  
compiled  and  consolidated  to  define  monetary  aggregates.  
responsibilities,  the  whole  of  the  commercial  banking  sector  and  the  
 
money  market  funds.  When  we  talk  about  the  balance  sheet  of  the  
The  financial  sector  is  the  broadest  group  of  financial  intermediaries  
depository  corporation  sector,  we  refer  to  the  aggregate  balance  
for  which  statistics  are  collected.  In  the  monetary  and  financial  
sheet  of  all  these  intermediaries.  
statistics,  we  distinguish  financial  intermediaries  on  the  basis  of  
 
whether  they  are  allowed  or  not  to  collect  deposits  from  the  
The  sector  of  other  financial  corporations  comprises  the  pension  
general  public  for  safekeeping.  
funds,  the  insurance  sector,  the  leasing  companies,  and  many  other  
 
types  of  financial  intermediaries  that  do  not  collect  deposits  but  
The  depository  corporations  sector  provides  the  means  of  
offer  financial  services.  
payments,  collects  deposits,  and  channels  resources  to  economic  
The  full  accounts  of  the  central  bank  are  called  Central  Bank  Survey.  
activity.  The  other  financial  corporations  may  not  collect  deposits  
The  accounts  of  the  other  deposit-­‐taking  institutions,  ODCs,  
and  comprises  of  all  those  institutions  that  provide  other  types  of  
are  consolidated  in  the  Other  Depository  Corporation  Survey.  
financial  services,  such  as  annuities,  insurances,  and  many  other  
 
types  of  financial  products.  
When  we  consolidate  the  accounts  of  the  central  bank  with  those  of  
 
the  other  deposit  taking  institutions,  we  obtain  the  Depository  
It  is  important  to  keep  in  mind  that  these  are  the  names  used  in  the  
Corporation  Survey.  
Statistical  Manual,  because  the  common  language  word  is  usually  
In  the  past,  this  used  to  be  called  the  Monetary  Survey.  The  
not  very  specific.  
accounts  of  the  other  financial  intermediaries  that  do  not  belong  to  
 
For  example,  we  commonly  refer  to  the  group  of  deposit-­‐  
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the  depository  corporations  sector  are  aggregated  in  the  Other   The  accounts  show  the  stock  of  assets  and  liabilities,  or  the  
Corporations  Survey.   statement  of  the  financial  position  of  a  specific  group  of  
When  the  accounts  of  the  depository  corporations  are  consolidated   intermediary.  For  monetary  analysis,  the  flow  of  liabilities  is  also  
with  the  accounts  of  the  other  financial  corporations,  we  have  the   important.  The  accounts  of  the  monetary  and  financial  statistics  
Financial  Corporations  Survey.   are  valued  at  fair  value  at  the  end  of  the  reference  period.  
The  consolidated  liabilities  of  the  deposit-­‐taking  institutions  will   All  entries  will  be  in  national  currency,  or  foreign  currency  
include  all  the  deposits  in  the  system  and  are  structured  to  present   for  those  countries  where  this  is  used  as  a  national  currency  unit.  
broad  money  aggregates.    
  Each  account  presents  gross  assets  and  gross  liabilities  by  residency,  
A  simple  scheme  can  represent  the  three  levels  of  compilation  of   by  sector  of  economic  counterparty,  by  type,  by  maturity.  Some  
monetary  and  financial  statistics.   items  will  be  presented  on  a  net  basis,  so  that  a  negative  entry  for  a  
  net  asset  is  interpreted  as  a  net  liability.  
The  first  and  most  disaggregated  level  contains  the  separate    
balance  sheets  for  the  central  banking  activities  and  the  rest   In  the  course  of  this  lecture,  we  will  be  looking  at  the  analytical  
of  the  deposit-­‐taking  activities.   presentation  of  the  accounts  of  the  different  financial  
  intermediaries.  
The  second  level  consolidates  the  data  for  the  depository    
corporation  sector.  The  liabilities  of  the  depository  corporations   This  means  that  the  assets  and  liabilities  are  aggregated  into  
sector  represent  a  measure  of  the  stock  of  money,  which  we  call   concepts  that  are  relevant  for  monetary  policy  analysis.  
broad  money,  or  M2.    
  To  summarize,  we  have  learned  the  financial  sector  is  divided  in  two  
The  third  level  consolidates  the  monetary  survey  and  the  balance   main  groups  of  financial  intermediaries,  depending  whether  they  
sheets  of  the  other  financial  corporations  into  the  financial   are  allowed  or  not  to  collect  deposits  from  the  public.  
corporations  survey.   The  consolidated  liabilities  of  the  deposit-­‐taking  institutions  
  will  cover  all  the  deposits  in  the  system  and  are  aggregated  to  
In  countries  where  financial  markets  are  not  well  developed,   present  broad  money  aggregates.  
the  banking  system  typically  accounts  for  the  bulk  of  an  economy's    
financial  assets  and  liabilities.  The  statistics  present  the  accounts  for   Monetary  and  financial  statistics  present  the  stock  value  in  the  
each  component  of  the  financial  sector.   accounts  at  the  end  of  the  accounting  period  and  valued  at  fair  
  value.    
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VIDEO  3:  The  Central  Bank   it  will  prevent  that  a  confidence  crisis  in  one  element  of  the  banking  
  system  can  spill  over  to  the  rest  of  the  sector.  
The  Central  Bank.    
The  central  bank  is  the  national  financial  institution  that  exercises   The  central  bank  is  also  in  charge  of  issuing  the  domestic  currency.  
control  over  key  aspects  of  the  financial  system.   The  central  bank  creates  high-­‐powered  money,  also  known  as  the  
  monetary  base,  or  reserve  money,  and  thus  exercises  control  over  
What  are  the  main  functions?   the  amount  of  high-­‐powered  money  in  the  economy.  This  is  the  
An  important  function  of  the  central  bank  is  to  act  as  a  lender  of  last   main  route  through  which  the  central  bank  controls  the  money  
resort  to  the  system-­‐-­‐  LOLR.   supply  in  the  economy.  
   
When  financial  panic  threatens  a  bank,  or  even  the  whole  banking   The  monetary  base  comprises  the  central  bank  liabilities  toward  the  
system,  the  central  bank  will  need  to  take  swift  action  to  restore   rest  of  the  system.  And  through  the  monetary  base,  the  central  
investor  confidence.   bank  controls  the  supply  of  money  in  the  economy.  Therefore,  an  
  analysis  of  its  balance  sheet  is  key  to  understanding  the  process  of  
The  rationale  for  using  the  central  bank  as  a  lender  of  last  resort  is   money  creation.    
based  on  the  essentially  illiquid  nature  of  the  credit  system.    
The  liabilities  of  banks,  such  as  deposits,  are  typically  of  very  short   The  central  bank  creates  monetary  base  whenever  it  acquires  assets  
maturity.   from  the  private  sector,  because  by  making  a  payment,  it  writes  a  
However,  the  loans  that  comprise  the  assets  have  much  longer   check  against  itself.    
term.    
If  all  creditors  ask  for  their  cash  at  the  same  time,  some  banks  may   Another  important  function  of  the  central  bank,  related  to  its  role  
be  pushed  into  default.   as  the  issuer  of  the  currency,  is  to  conduct  monetary  policy.  
   
If  one  bank  has  payment  difficulties,  depositors  across  the  country   In  many  countries,  it  would  also  hold  the  foreign  reserves  of  the  
may  fear  for  their  savings,  and  they  may  all  rush  to  claim  their   country.  Although,  there  are  some  countries  in  which  the  treasury,  
deposits  from  their  respective  banks.  Then,  the  entire  banking   or  a  treasury-­‐  controlled  stabilization  fund,  would  hold  the  official  
system  may  become  illiquid.   reserves.  
   
To  prevent  financial  collapse,  the  central  bank  can  lend  to  the   In  many  countries,  it  would  also  act  as  a  banker  for  the  government  
problem  bank  and  guarantee  payment  to  its  depositors.  Therefore,   and  generally  oversee  the  soundness  of  the  financial  sector.  
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Under  IMF  accounting  procedures,  the  monetary  functions  of  the   It  is  important  to  note  that  the  monetary  base  excludes  the  deposits  
government  are  grouped  with  the  accounts  of  the  central  bank,   of  both  the  government  and  the  non-­‐residents  with  the  central  
so  that  all  the  functions  of  monetary  authorities  are  presented   bank.  
under  one  accounting  unit.    
  These  are  netted  against  the  claims  of  the  central  bank  towards  the  
It  is  also  important  to  note  that  the  activities  of  a  central  bank   government  and  the  claims  of  the  central  bank  towards  foreign  
can  be  performed  by  different  types  of  institutions—an  actual   residents  in  the  asset  side  of  the  balance  sheet.  
central  bank,  a  currency  board,  or  independent  currency    
authorities,  or  government-­‐affiliated  agencies  that  perform  central   Now,  turning  to  the  asset  side,  the  central  bank  holds  the  country's  
banking  activities.   foreign  reserves.  These  are  included  in  the  Net  Foreign  Asset  
  concept.  NFA  includes  official  foreign  reserves,  monetary  gold,  SDR,  
The  central  bank  exercises  control  over  the  amount  of  high-­‐ and  the  reserves  position  in  the  IMF.  
powered  money  in  the  economy.  As  we  mentioned  earlier,  we  use    
an  analytical  balance  sheet  of  the  central  bank  to  present  the   While  in  many  countries  the  net  foreign  assets  of  the  central  bank  
aggregate  concepts  that  are  relevant  for  monetary  policy  analysis.   are  equated  with  a  net  official  international  reserves,  the  definition  
The  monetary  base  represents  the  liabilities  of  the  central  bank.   of  net  foreign  assets  is  broader  than  the  definition  of  net  official  
  international  reserves.  
The  monetary  base  is  comprised  of  the  currency  that  is  issued    
and  that  is  held  both  by  the  general  public  and  in  the  banks-­‐-­‐   Net  Domestic  Assets  of  the  central  bank  are  usually  divided  in  net  
also  known  as  cash  in  vault.   domestic  credit  and  other  items,  which  is  a  residual  category  usually  
  shown  on  a  net  basis.  
The  deposits  of  the  other  depositary  corporations  with  the  central    
bank  are  also  liabilities  of  the  central  bank.   In  turn,  net  domestic  credit  is  comprised  of  net  credit  to  the  rest  of  
  the  private  sector  and  net  claims  on  the  government.  
And  finally,  there  are  liabilities  that  the  central  bank  has  towards    
the  rest  of  the  economy  that  are  included  in  the  national  concept  of    
broad  money.   The  operations  between  the  government  and  the  central  bank  are  
These  will  include  the  deposits  of  other  financial  institutions  and  the   shown  on  a  net  basis,  because  the  government  has  easier  access  
non-­‐financial  private  sector,  such  as  private  individuals,  firms,  or   to  credit  than  other  sectors.  
foreign  currency  deposits  by  residents.    
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So  its  expenditures  are  not  usually  constrained  by  deposits  or  cash   later,  but,  in  principle,  liquid  reserves  of  banks  serve  as  protection  
balances.  The  claims  on  the  other  depository  corporations   against  unexpected  depositor  withdrawals.  Each  licensed  bank  has  
represent  the  lending  operation  between  the  central  bank   an  account  at  the  central  bank  where  their  required  reserves  are  
and  the  commercial  banking  sector.   deposited.  
   
These  include  all  direct  credits  to  banks  and  the  bills  of  exchange  for   Required  reserves  are  established  by  the  regulator  as  a  fraction  of  
discount  from  banks  accepted  by  the  central  bank.  We  will  see  later   private  sector  deposits  in  the  banks.  
how  both  the  amount  of  central  bank  lending  to  the  ODC  and  the    
discount  rate,  which  is  the  interest  rate  that  the  central  bank   Excess  reserves  are  maintained  by  banks  on  a  voluntary  basis,  and  
charges  on  the  loans  to  the  banks,  are  instruments  of  monetary   depend  on  the  opportunity  cost  of  other  investments  and  the  
policy.   bank's  propensity  to  keep  liquid  reserves.  
   
The  claims  on  the  other  domestic  economic  sectors  are  lending   As  we  saw,  the  monetary  base  is  the  main  liability  of  the  central  
operations  to  other  sectors,  which  are  usually  insignificant,  but  may,   bank.  
at  times,  be  large  depending  on  monetary  policy  decisions.   From  the  construction  of  the  balance  sheet  of  the  central  bank,  
  we  can  see  that  the  monetary  base  is  equal  to  the  sum  of  net  
Finally,  the  residual  category,  other  items,  net,  usually  includes  the   foreign  assets  and  net  domestic  assets  of  the  central  bank.  
central  bank  capital,  the  accumulated  operating  losses  or  surpluses   We  can  write  this  identity  in  terms  of  flows.  
from  the  central  bank,  and  the  counterpart  of  valuation  changes.   This  implies  that,  for  example,  when  an  overall  surplus  on  the  
  balance  of  payments  adds  to  the  net  international  reserves  
  of  the  central  bank—all  else  equal-­‐-­‐  this  will  increase  the  monetary  
VIDEO  4:  The  Central  Bank  (continued)   base.  
   
  The  reverse  will  hold  for  a  deficit  in  the  balance  of  payments.  In  a  
An  important  component  of  the  monetary  base  is  represented  by   similar  way,  if  the  central  bank  buys  government  securities  or  makes  
the  deposits  of  the  other  depositary  corporations  at  the  central   loans  to  banks,  this  will  increase  the  domestic  assets  which—all  else  
bank.   equal-­‐-­‐  will  result  in  an  increase  in  the  monetary  base.  
   
These  are  commonly  referred  to  as  bank's  reserves.  The  rationale   We  can  link  the  monetary  base  to  the  assets  of  the  central  bank,  
for  establishing  required  reserves  will  be  discussed  more  at  length   and  we  can  now  see  how  the  central  bank  can  influence  monetary  
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conditions  through  its  influence  on  the  monetary  base.  In  effect,  all   government  securities  will  increase,  with  a  counterpart  increase  in  
central  bank  operations  which  affect  net  domestic  assets,  such  as   liabilities,  i.e.  in  the  monetary  base  in  the  form  of  the  increase  
lending  to  the  government,  open  market  purchases  or  sales  of   of  the  currency  in  circulation.  
government  securities,  lending  to  the  banks,  purchases  and  sales  of    
foreign  exchange,  and  lending  to  the  rest  of  the  private  sector,  will   When  the  government  finances  its  deficit  by  borrowing  from  the  
lead  to  an  increase  in  the  monetary  base.   central  bank,  the  claims  of  the  central  bank  against  the  government  
  will  increase.  
Because  when  the  central  bank  makes  payments  to  domestic    
residents,  it  writes  a  check  against  itself.   If  the  money  remains  as  a  government  deposit  at  the  central  bank,  
  then  the  net  position  of  the  central  bank,  vis-­‐a-­‐vis  the  government,  
The  residents  can  deposit  the  money  they  receive  in  the  form  of   will  not  change,  and  therefore,  there  will  be  no  change  in  the  
checks  in  the  banks  which,  in  turn,  will  deposit  them  at  the  central   monetary  database.  
bank.    
  But  when  the  government  uses  the  borrowed  money  to  make  a  
The  resulting  increase  in  bank  deposits  with  the  central  bank   payment  to  the  private  sector,  the  stock  of  monetary  base  rises  
will  add  to  the  monetary  base.  No  other  entity  in  the  economy  has   because  the  government's  deposits  with  the  central  bank  are  
this  ability.  By  virtue  of  being  the  monopoly  supplier  of  base  money,   reduced.  
the  central  bank  is  the  undisputed  arbiter  of  monetary  policy.    
  When  the  central  bank  intervenes  in  the  foreign  exchange  market,  
  for  example,  to  defend  a  particular  level  of  the  exchange  rate  or  to  
For  example,  let's  see  how  the  central  bank  can  conduct  open   acquire  a  desired  amount  of  international  reserves,  the  intervention  
market  operations.   directly  affects  base  money,  as  the  volume  of  NFA  will  change.  
   
These  will  entail  the  purchase  of  securities,  either  issued  by  the   And  hence,  it  will  have  a  direct  impact  on  overall  liquidity  in  the  
government  or  issued  by  the  central  bank,  and  in  the  secondary   economy  and  the  stance  of  monetary  policies.  
market.  In  so  doing,  the  central  bank  will  change  the  stock  of  the    
monetary  base.   The  central  bank  can  also  influence  base  money  through  the  
  quantity  and  terms  of  its  lending  to  the  domestic  banking  sector.  
When  the  central  bank  purchases  government  securities  because  it  
is  financing  the  government's  deficit,  the  central  bank's  holding  of  
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Typically,  the  central  bank  lends  to  the  domestic  banks  through  a   VIDEO  5:  CB  Balance  Sheet  
discount  window.  The  discount  mechanism  is  an  instrument  of    
monetary  control.   Let  us  take  a  look  at  a  numerical  example  of  how  the  central  bank  
  can  influence  the  monetary  base.  As  we  have  seen,  the  monetary  
The  most  important  of  the  arrangement  is  the  rate  of  interest   base  is  equal  to  the  sum  of  net  foreign  assets  (NFAs)  and  net  
charged.   domestic  assets  (NDAs).  
The  central  bank's  credit  to  the  banks  is,  in  practice,  the  source  of    
base  money  most  directly  under  its  control.   If  the  central  bank  buys  100  worth  of  government  securities  in  the  
An  increase  in  the  interest  rate  the  central  bank  charges  signals  its   open  market,  its  claims  against  the  government  will  increase  by  an  
intention  to  tighten  monetary  conditions.   equivalent  amount  and  so  will  the  NDA.  
   
By  making  such  borrowing  more  costly,  it  tends  to  reduce  bank   The  counterpart  of  this  operation  will  be  a  payment  of  100  for  the  
borrowing  from  the  central  bank  while,  at  the  same  time,  inducing   securities  to  the  banks,  which  will  increase  the  central  bank's  
banks  to  increase  their  holding  of  excess  reserves.   liabilities  to  the  ODCs  by  100.  This  will  result  in  an  increase  of  100  in  
  the  monetary  base.  In  the  next  example,  we  can  see  how  the  
One  important  thing  to  note  is  that  the  central  bank  can  sterilize  its   purchase  of  70  worth  of  foreign  currency  from  the  banks  leads  to  an  
operation  to  generate  an  increase  in  the  monetary  base  by  making   equivalent  increase  in  the  monetary  base  and  in  NFAs  of  the  central  
an  offsetting  operation.   bank,  after  the  central  bank  pays  the  banks  for  the  foreign  currency.  
   
For  example,  it  can  offset  the  purchase  of  an  asset—for  example,   In  this  example,  the  purchase  is  said  to  be  un-­‐sterilized  because  
government  securities  of  foreign  exchange—by  the  selling  of   there  is  no  other  counterbalancing  action  by  the  central  bank.  In  the  
another  asset.  Thus,  the  monetary  base  will  not  change.   third  example,  we  should  see  the  effect  of  the  purchase  of  70  of  
  foreign  currency  from  the  banks  and  a  concurrent  sale  of  
In  this  case,  we  say  that  the  initial  action,  i.e.  the  purchase  of  an   government  bonds  to  the  banks—the  increase  of  70  in  foreign  
asset,  has  been  sterilized,  in  the  sense  that  its  impact  on  the   assets  paid  by  the  central  bank  and  a  concurrent  sale  of  government  
monetary  base  and  hence  on  the  overall  liquidity  condition  in  the   bonds,  which  will  then  reduce  domestic  assets.  
economy  has  been  offset.    
  The  deposits  of  the  ODCs  will  reduce  in  the  equivalent  amount  
and  thus  the  monetary  base  will  then  be  unchanged.  When  the  
central  bank  conducts  operations    designed  to  leave  the  monetary  
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base  unchanged,  after  purchases  of  foreign  currency  or  government   bank  because  of  mandatory  requirements  or  to  keep  liquidity  
securities,  it  is  said  to  be  "sterilizing"  and  this  operation  is   buffers.  
"sterilized."    
  The  net  foreign  assets  refer  to  the  position  vis-­‐a-­‐vis  non-­‐residents  
 Finally,  let's  look  at,  how  would  a  revaluation  of  foreign  assets   and  net  domestic  assets  refer  to  the  position  of  the  central  bank  vis-­‐
affect  the  accounts  of  the  central  bank?   à-­‐vis  residents.  The  components  of  the  net    domestic  assets  
  are  net  claims  on  the  government,  the  central  bank  claims  on  the  
Let's  assume  in  this  case  that  the  central  bank  has  an  equivalent   other  depositary  corporations  and  the  bonds  issued  for  stabilization  
amount  of  50  in  NFAs    and  NDAs  of  50.  The  monetary  base   purposes.  
will  be  equal  to  100.  Let's  assume  that  the  revaluation  of  the    
domestic  currency  vis-­‐a-­‐vis  the  foreign  currency  reduces  the  value   Finally,  other  items,  net  will  include  the  capital  of  the  central  bank.  
of  the  holdings  of  the  central  bank  net  foreign  assets  by  10,   It's  interesting  to  note  that  the  stabilization  bonds  issued  by  the  
generating  an  equivalent  valuation  loss  for  the  central  bank.   central  bank  are  booked  on  the  asset-­‐side,  despite  the  fact  that  they  
  are  actually  liabilities  of  the  central  bank.  
To  account  for  the  reduction  in  the  value  of  the  NFAs,  we  will  need    
to  book  an  equivalent  increase  in  the  revaluation  account.  This  is  in   The  reason  for  this  is,  is  that  they  are  excluded  from  the  monetary  
the  other  items,  net  category  of  the  central  bank.   base.  The  same  reasoning  applies  to  the  capital  account  of  the  
  central  bank,  which  is  also  excluded  from  the  concept  of  high-­‐
The  revaluation  account  will  register  an  increase  of  10.  This  will   powered  money.  We  can  use  the  statistics  to  examine  what  could  
appear  as  a  reduction  of  the  capital  of  the  central  bank  because  the   have  been  taking  place  in  the  last  two  years  in  this  country.  We  can  
capital  of  the  central  bank  is  booked  as  a  negative  asset  and  then  a   check  that  between  2010  and  2011,  the  monetary  base  has    
loss  will  actually  imply  an  increase  in  the  capital.  NDAs  will  then  be   expanded  by  186,  of  which  83  corresponds  to  an  increase  in  NFA  
60.  The  assets  of  the  central  bank  are  then  unchanged.   and  103  to  an  increase  in  NDA.  
   
Let's  now  take  a  look  at  an  example  of  central  bank  accounts.  Let's   When  we  look  at  the  breakdown  of  the  NDAs,  a  large  share  of  the  
first  check  for  the  balance  sheet  identity.  We  can  see  that  the   increase  is  the  reflection  of  a  drawdown  of  government  deposits,  
monetary  base  of  2218  is  exactly  equal  to  the  sum  of  2446  and  -­‐228.   which  reduced  by  202  and  therefore  generates  an  equivalent  
The  monetary  base  is  composed  of  currency  in  circulation  and  the   increase  in  net  credit  to  the  government.  At  the  same  time,  there  is  
liabilities  to  the  other  depository  corporations.  As  we  mention,   an  increase  in  claims  vis-­‐a-­‐vis  the  banking  sector,  which  suggests  
these  will  be  the  deposits  that  the  ODCs  will  keep  at  the  central  
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that  the  central  bank  has  been  extending  liquidity  to  the  local   Let's  now  take  a  break.  
banking  sector.    
   
A  closer  look  at  the  balance  sheet  of  the  central  bank  also  reveals   VIDEO  6:  Other  Depositary  Corporations  
that  the  monetary  policy  authorities  have  sought  to  sterilize  the    
increase  in  the  monetary  base  by  issuing  monetary  stabilization   Other  Depository  Corporations.  
bonds,  as  they  have  increased  by  405  over  the  period.  In  this   The  Other  Depositary  Corporations  are  deposit-­‐taking  financial  
particular  country,  the  central  bank  issues  its  own  liabilities  to   institutions.  
control  the  monetary  base.    
  And  we  call  them  "other"  because  they  are  financial  institutions  that  
We  can  also  note  that,  most  likely,  the  issuance  of  its  own   collect  deposits  other  than  the  Central  Bank.  
stabilization  bonds  is  generating  a  drain  on  the  resources  of  the    
central  bank,  as  evidenced  by  the  large  increase  in  the  capital   The  ODCs  include  commercial  banks,  merchant  banks,  savings  and  
position  of  the  central  bank,  which  represents  a  loss.   loans  institutions,  cooperative  banks,  that  we  call  in  general  
  language  words,  the  banking  sector.  
Let's  now  summarize  what  we  have  seen  in  this  class.  We  have    
learned  that  the  central  bank  is  the  entity  in  charge  of  issuing  the   As  we  have  seen  in  the  introductory  class,  the  ODCs  are  resident  
currency,  regulating  the  banking  sector,  and  acting  as  a  lender  of   financial  intermediaries  that  collect  deposits  from  the  general  
last  resort  for  financial  institutions  in  distress.     public.  
   
We  have  analyzed  the  accounts  of  the  central  bank  and  we  have   And  the  deposits  of  the  public,  which  are  liabilities  in  the  balance  
noted  how  the  monetary  base  or  high-­‐powered  money  constitutes   sheets  of  the  ODCs,  are  included  in  the  concept  of  broad  money.  
the  liabilities  of  the  central  bank.  We  have  noted  the  balance  sheet   The  ODC  sector  provides  several  important  services  to  the  local  
identity  for  the  central  bank,  whereby  the  monetary  base  is  equal  to   economy.  In  the  first  place,  they  collect  deposits  from  the  general  
the  sum  of  net  foreign  assets  and  net  domestic  assets.   public,  and  keep  them  safe.  
   
Finally,  we  have  learned  how  the  central  bank  can  take   They  can  use  the  resources  they  have  collected  to  extend  loans  to  
countervailing  measures  to  ensure  that  the  stock  of  the  monetary   corporations  to  finance  investment  projects  and  thereby  support  
base  remains  unchanged,  even  if  it  is  changing  other  items  in  its   growth  in  the  economy.  
balance  sheet.      
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They  also  transform  deposits,  which  are  very  short-­‐term  in  nature,   The  assets  of  commercial  banks  focus  on  credit  extended  to  the  
into  longer  term  assets,  such  as  securities  and  loans.   resident  and  nonresident  sector,  just  as  the  Central  Bank  case.  
   
The  decisions  of  the  ODCs,  with  respect  to  the  collection  of  deposits   Commercial  banks  typically  hold  foreign  assets  because  they  finance  
and  the  extension  of  loans,  influence  the  amount  the  liquid   foreign  trade  operation  and  engage  in  operation  with  the  rest  of  the  
resources  private  sector  agents  can  dispose  and  thus  the  overall   world.  The  position  of  commercial  banks,  vis-­‐a-­‐vis,  the  non-­‐resident  
amount  of  liquidity  circulating  in  the  economy.  Because  of  this,  the   sector,  is  presented  on  a  net  basis.  
ODC  sector  constitutes  an  important  instrument  for  the    
transmission  of  monetary  policy  to  the  rest  of  the  economy.   The  largest  share  of  commercial  banks'  assets  is  typically  
  represented  by  the  lending  operations,  which  usually  comprise  
The  statistics  on  the  ODCs  present  the  accounts  for  the  whole  sector    of  lending  to  the  government  and  the  rest  of  the  public  sector,  
on  a  consolidated  basis.  The  ODC  Survey  is  constructed  so  that  the    and  lending  to  the  rest  of  the  economy.  
liability  side  includes  all  those  liabilities  of  the  ODCs  that  are    
included  in  the  concept  of  broad  money.   Because  a  large  share  of  their  liabilities  can  be  called  upon  at  any  
  time  by  their  customers,  banks  have  to  hold  significant  share  of  
The  liabilities  of  commercial  banks  are  mainly  constituted  by   their  assets  in  reserves,  which  will  give  them  immediate  access  
deposits  and  they  are  classified  by  type  of  instrument  according  to   to  cash  to  redeem  their  deposits.  
their  maturity.  Demand  deposits  are  deposits  which  are  made    
readily  available  to  the  customers  upon  demand.  All  deposits  with  a   The  reserves  of  the  banks  are  typically  held  in  cash  or  T-­‐bills.  
maturity  less  than  a  year  are  usually  included  in  the  demand  deposit    
category.   Required  reserves  are  the  amount  which  is  required  to  be  deposited  
  with  the  Central  Bank.  
Time  and  savings  deposits  are  deposits  of  the  public  with  a  maturity    
of  a  year  or  more.   Excess  reserves  are  those  held  by  the  banks  in  excess  of  the  
  minimum  required  and  they  are  usually  kept  for  prudential  reasons.  
Foreign  currency  deposits  are  deposits  of  the  public  which  will  be   The  amount  of  excess  reserves  the  bank  holds  typically  depends  on  
paid  out  in  foreign  currency.  All  the  remainder  of  the  liabilities  are   the  discount  rate;  that  means,  how  expensive  it  is  to  borrow  from  
liabilities  that  banks  have  vis-­‐a-­‐vis  the  monetary  authority,  and   the  Central  Bank.    
other  less  liquid  liabilities.    
 
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And  also  depends  on  the  efficiency  of  the  payment  system;   This  is  evidenced  by  a  decline  in  the  NFA  of  493.  This  is  evidence  of  
therefore,  how  many  liquid  reserves  banks  have  to  keep  for   significant  foreign  capital  inflows.  We  already  know,  from  the  
transactional  purposes.     balance  sheet  of  the  Central  Bank,  that  the  Central  Bank  has  been  
  buying  some  of  the  inflows  and  sterilizing  the  expansion  of  the  NFA  
The  last  item  on  the  balance  sheet  of  the  ODCs  is  a  category  that   by  issuing  its  own  bonds.  The  inflow  of  foreign  capital  or,  the  
includes  all  items  not  elsewhere  classified.  In  particular,  it  will   increase  of  borrowing  from  abroad  by  the  domestic  banking  sector,  
include  long-­‐term  liabilities,  which  are  not  included  in  the  definition   has  been  accompanied  by  a  significant  expansion  of  the  NDA  of  the  
of  broad  money,  such  as  capital.   banks    and,  in  particular,  a  significant  increase  in  credit  
  to  the  rest  of  the  private  sector.  This  has  increased  by  1,111.  
It  also  will  include  the  valuation  accounts,  just  as  in  the  case  of  the    
Central  Bank.   Let's  now  summarize  what  we  have  been  seeing  in  this  lecture.  
   
Let's  now  take  a  look  at  an  example  of  ODC  accounts.     We  have  learned  what  are  the  main  functions  of  the  ODCs.  And  that  
  is  to  collect  deposits  from  the  public.  The  ODCs  can  use  resources  
As  in  the  case  for  the  Central  Bank,  the  assets  are  broken  down  by   collected  to  extend  loans  to  the  rest  of  the  economy.  
residence  and  by  sector  of  economic  activity.  The  liabilities  are    
constituted  mainly  by  deposits,  which  will  be  broken  down  by   This  function  influences  the  degree  of  liquidity  in  the  economy.  
maturity.   We  have  also  seen  how  the  consolidated  balance  sheets  of  the  ODC  
  assets  are  broken  down  by  residence  and  sector  of  economic  
The  assets  are  mostly  composed  by  the  credit  to  the  rest  of  the   activity.  
private  sector.    
  We  have  also  learned  that  deposits  are  the  main  liabilities  
The  other  important  assets  are  the  claims  of  the  ODCs,  vis-­‐a-­‐vis,  the   of  the  consolidated  balance  sheets  of  the  ODCs  and  we  usually  
Central  Bank.  These  will  be  currency,  mandatory  reserve  deposits,   break  them  down  by  maturity  and  by  residents.  
and  excess  reserves.   Let's  now  take  a  break.  
   
If  we  take  a  look  at  what  has  been  happening  between  2010  and    
2011,  we  can  see  a  significant  accumulation  of  liabilities  vis-­‐a-­‐vis,  
 
the  non-­‐residents.  
 
 
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VIDEO  7:  Depositary  Corporations  Survey   Let's  take  a  close  look  at  which  would  be  the  position  that  needs  to  
  be  netted  out  between  the  central  bank  and  the  ODCs.  
The  Depository  Corporations  Survey.   In  the  first  place,  any  loans  of  the  central  bank  to  the  banks  will  
The  Depository  Corporations  Survey  is  constructed  by  consolidating   have  to  be  netted  against  the  liabilities  of  the  banks  to  the  central  
the  balance  sheets  of  the  central  bank  and  that  of  the  other   bank.  
depositary  corporations.    
  They  will  therefore  disappear  from  the  consolidated  accounts.  
This  DCS  allows  monitoring  the  development  in  the  consolidated    
banking  sector.  It  is  designed  so  that  they  consolidated  liabilities  of   In  the  second  place,  the  liabilities  of  the  central  bank  to  the  banks  in  
the  central  bank  and  of  the  commercial  banks  will  present  broad   the  form  of  currency  will  have  to  be  netted  against  the  holdings  of  
money  aggregates.   currency  of  the  banks.  
   
The  Depository  Corporations  Survey  used  to  be  called  the  Monetary   These  will  also  disappear  in  consolidation.  
Survey.   Finally,  the  deposits  of  the  banks  in  the  Central  Bank  and  assets  for  
It  links  broad  money  to  the  foreign  assets  and  the  claims  on  the   the  banks,  which  are  held  either  for  regulatory  or  voluntary    
domestic  economy  of  the  whole  depository  corporations  sector,   purposes,  will  have  to  be  netted  against  the  liabilities  of  the  central  
thereby  linking  monetary  statistics  to  the  BOP  and  Government   bank  in  the  form  of  deposits  to  the  banks.  
Finance  Statistics.    
  Once  off-­‐setting  positions  of  depository  corporations  among  each  
The  main  benefits  are  the  consolidated  presentation  of  the   other  are  netted,  we  can  construct  and  the  consolidated  balance  
accounts  of  the  entire  banking  system.   sheet  for  the  system.  
It  presents  the  evolution  of  the  stock  of  broad  money.    
And  it  allows  policymakers  to  adjust  monetary  policy.   First  of  all,  we  break  down  the  assets  of  the  ODCs  by  sector,  namely,  
  in  credit  to  the  public  sector  and  to  the  private  sector.  
To  construct  the  Depository  Corporations  Survey,  we  need  to    
consolidate  the  balance  sheets  of  the  central  bank  and  of  the  ODCs.   We  can  now  sum  each  of  these  two  categories  to  their  respective  
  category  from  the  central  bank.  
As  with  any  consolidation,  the  process  requires  the  netting  of    
offsetting  positions  across  institutions  in  the  DC  sector.  
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In  this  way,  we  can  compute  the  total  credit  provided  to  the  public   Let's  summarize  what  it  does.  
sector  and  to  the  private  sector  by  the  depository  corporations    
sector.   It  consolidates  the  claims  of  the  depository  corporations  sector  on  
  residents  It  consolidates  the  claims  against  non-­‐residents.  
We  are  now  able  to  see  how  much  the  government  and  the  private    
sector  has  been  borrowing  or  saving  in  the  banking  sector.   It  consolidates  the  liabilities  of  the  DC  sector  that  constitute  broad  
Next,  we  can  consolidate  the  position  vis-­‐a-­‐vis  non-­‐residents  of  both   money.  The  sum  of  currency  in  circulation  and  transferable  deposits  
the  central  bank  and  the  commercial  banks.   will  constitute  M2,  the  money  supply.  
This  position  summarizes  the  net  position  of  the  depository    
corporations  sector  vis-­‐a-­‐vis  non-­‐residents.   The  presentation  of  the  accounts  of  the  DCs  will  be  similar  to  that  of  
  its  sub-­‐components,  the  central  bank  and  the  ODCs,  and  will  have  
A  positive  net  position  implies  that  lending  to  non-­‐residents  has   on  the  liability  side  overall  liquidity  generated  by  the  depository  
been  taking  place.   corporations  sector,  or  the  stock  of  broad  money.  
   
A  negative  position  indicates  a  net  inflow  of  foreign  resources  in  the   This  will  include  all  types  of  liabilities  of  the  whole  DC  sector,  which  
economy  through  an  accumulation  of  liabilities  to  non-­‐residents.   are  transferable,  redeemable  at  no  or  very  little  cost  and  that  have  a  
  relatively  short  maturity.  
Finally,  the  "other  item,  net"  category  will  include  the  sum  of  the    
residual  accounts  of  the  central  bank  and  on  all  of  the  ODCs,  net  of   Currency,  transferable  deposits,  which  will  be  demand  deposits,  
any  offsetting  position,  and  including  any  liability  of  either   time  and  savings  as  we  have  seen  them  before,  money  market  
institution  that  is  excluded  from  broad  money.   funds,  and  foreign  currency  deposits.  
   
On  the  liability  side,  after  the  netting  of  positions,  currency  in   Other  deposits  against  which  it  is  possible  to  write  checks  and  other  
circulation  of  outside  banks  will  be  the  most  liquid  liability  of  the   securities  which  have  a  relatively  short  maturity.  
depository  corporations.   On  the  asset  side,  the  depository  corporations  (survey)  will  show  
  the  claims  of  the  DC  sector  by  residency  and  net  domestic  assets  
And  then  we  will  be  left  with  the  deposits  in  the  banking  sector    by  sector  of  economic  activity:  lending  to  the  government,    lending  
included  in  broad  money.  Now  we  have  constructed  a  depository   to  the  rest  of  the  residents  sector.  
corporations  survey.      
 
 16

The  other  items  net  category  will  represent  a  consolidated  concept   We  can  also  check  that  the  net  foreign  asset  position  will  be  exactly  
of  other  items  net,  including  capital  and  valuation  accounts,  net  of   equal  to  the  sum  of  the  foreign  asset  position  of  the  other  
inter-­‐sectoral  flows,  and  also  all  those  liability  items  of  the   depository  corporations  and  the  central  bank.  
depository  corporations  sector  that  are  not  included  in  the  broad    
money  concept.   Finally,  we  can  check  that  the  net  credit  to  the  public  and  private  
  sector  for  the  Depository  Corporation  Survey  is  equal  to  the  sum  of  
Let's  now  take  a  break  before  we  look  at  an  example  of  the   the  claims  on  the  public  sector  by  the  banks  and  the  central  bank.  
Depository  Corporations  Survey  accounts.    
  We  can  now  see  why  the  DC  represents  the  evolution  of  the  
  monetary  aggregates  for  the  economy  as  a  whole.  
And  we  can  take  a  look  at  what  is  happening  to  this  economy.  
VIDEO  8:  DCS  Example  
 
 
We  note  that  the  position  vis-­‐a-­‐vis  non-­‐residents  is  deteriorating  
 
significantly  following  the  strong  capital  inflows  experienced  by  the  
Hello,  and  welcome  back.  
banking  sector.  
We  are  now  looking  at  an  example  of  a  Depository  Corporations  
 
Survey.  
The  accumulation  of  NFA  of  the  central  bank  is  not  sufficient  to  
 
offset  the  deterioration  in  the  other  depository  corporations  sector.  
We  can  see  that  in  the  first  place,  broad  money  is  composed  of  
We  also  note  that  the  decrease  in  NFAs  has  been  financing  both  
currency  in  circulation,  deposits,  and  other  liabilities  of  the  central  
credit  to  the  public  sector  and  credit  to  the  private  sector,  which  
bank.  
has  been  growing  rapidly  between  2010  and  2011.  
In  particular,  we  can  note  that  the  currency  and  circulation  will  be  
 
equal  to  the  total  currency  in  circulation  issued  by  the  central  bank,  
Finally,  despite  the  significant  increase  in  issuance  of  owned  bonds,  
less  what  is  held  in  the  vaults  of  the  other  depository  corporations.  
the  central  bank  has  had  a  limited  success  in  controlling  growth  of  
 
broad  money.  
The  deposits  of  the  depository  corporations  will  include  the  
 
deposits  of  the  ODCs,  and  the  remainder  of  the  liabilities  of  the  
Let's  now  turn  to  the  discussion  on  the  money  aggregates.  
central  bank.  
 
 
As  we  have  seen,  the  depository  corporations  survey  presents  on  
the  liability  side  the  aggregates  included  in  the  national  definition  of  
 17

broad  money.  However,  the  broad  money  stock  can  be  defined  in   And  again,  we  can  break  down  net  domestic  assets  into  its  
different  ways.  The  most  commonly  used  definitions  are  referred  to   components.  This  implies  that  an  increase  in  the  credit  to  the  
as  M1  and  M2.   government,  extended  by  the  depository  corporations  sector,  will  
  increase  net  domestic  assets  and,  therefore,  the  outstanding  stock  
M1  and  M2  are  the  aggregates  the  central  bank  most  frequently   of  money.  
monitor  for  monetary  policy  decisions.  M1  includes  only  the  most    
liquid  assets,  while  M2  includes  also  some  less  liquid  types  of  assets,   By  converse,  we  can  interpret  an  increase  in  the  stock  of  money  
but  with  still  short  maturities.   as  financing  the  operations  of  the  non-­‐resident  sector.  
In  particular,  M1,  or  narrow  money,  is  defined  as  the  sum  of    
currency  in  circulation  and  demand  deposits.   If  the  increase  in  the  stock  of  money  finances  the  general  
While  M2,  or  broad  money,  also  includes  time  and  savings  deposits,   government  among  the  resident  sector,  then  we  will  also  observe  
money  market  funds,  and  foreign  currency  deposits.   an  increase  in  net  credit  to  the  government  by  depository  
We  have  seen  those  are  those  with  maturity  of  one  year  and  more,   corporations.  
but  still  short  term.   What  is  important  to  understand  is  how  the  DC  survey  is  linked  to  
  the  other  sectors  of  the  economy.  
These  are  usually  referred  to  as  "quasi-­‐money,"  so  that  M2  is  equal    
to  M1  plus  quasi-­‐money  aggregates.  The  identity  between  assets   In  the  first  place,  the  net  position  against  non-­‐residents  will  have  to  
and  liabilities  of  the  depository  corporations  sector  implies  that  the   be  related  to  the  balance  of  the  BOP.  We  know  that  the  change  in  
stock  of  broad  money  is  identical  to  the  sum  of  its  counterparts,   NFA  will  be  equivalent  to  the  reserve  accumulation  in  the  BOP.  
namely  net  foreign  assets  valued  in  domestic  currency,    
and  net  domestic  assets.   That,  in  turn,  will  be  equal  to  the  balance  on  the  current  account,  
  the  capital  account  balance,  the  financial  account  balance,  and  net  
We  can  also  break  down  net  domestic  assets  into  its  components.   errors  and  omissions.  
This  will  be  net  credit  to  the  government,  net  credit  to  the  rest  of    
the  private  sector,  and  other  items  net.  This  identity  will  also  hold   It  is  important  to  keep  in  mind  that  the  change  in  the  domestic  
for  the  flows.  An  increase  in  the  stock  of  broad  money  will  have  to   currency  of  the  value  of  reserves  also  includes  a  valuation  effect  
be  reflected  in  an  equivalent  increase  of  net  foreign  assets  and  net   that  will  be  included  in  the  other  item's  net,  as  we  have  seen  
domestic  assets.   before.  
   
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The  net  domestic  assets  of  the  Depository  Corporations  Survey  will   VIDEO  9:  Money  Creation  
be  linked  to  the  fiscal  sector  through  net  credit  to  the  government.    
  The  Money  Multiplier.  In  this  part  of  the  lecture,  we  will  cover  
This  includes  the  banking  system  lending  to  the  government  to   topics  in  monetary  analysis.  
finance  its  fiscal  deficit,  and  shows  how  monetization  of  the  fiscal    
deficit  has  a  direct  impact  on  the  money  stock.   To  begin,  we  will  explore  the  process  whereby  the  currency  issued  
  by  the  central  bank  is  transformed  in  deposits  and  ultimately  grows  
It  is  also  linked  to  the  real  sector.   to  become  broad  money.  This  process  evidences  the  importance  of  
On  the  asset  side,  credit  that  the  banking  system  provides  to  the   controlling  the  monetary  base  to  influence  the  amount  of  liquidity  
private  sector  impacts  development  and  growth.   in  the  economy.  
   
On  the  liability  side,  the  private  sector  demand  for  cash  balances   Let's  begin  the  discussion  by  analyzing  how  money  gets  created  in  
is  an  important  determinant  of  inflation.   the  economy.  As  we  know,  the  private  sector  will  not  keep  all  of  its  
We  can  then  understand  the  link  between  the  stock  of  money   earnings  in  the  form  of  currency  but  will  deposit  a  certain  part  of  
in  the  economy  and  the  financing  needs  or  surpluses  of  the   them  in  the  commercial  banks  for  safekeeping  and  savings  
different  sectors.   purposes.  We  do  not  usually  expect  the  depositors  will  demand  
  back  all  of  their  savings  at  once.  Therefore,  the  commercial  banks  
Today,  we  have  learned  how  the  balance  sheet  of  the  central  bank   can  use  part  of  the  amount  they  receive  in  the  form  of  deposits  to  
and  the  balance  sheets  of  the  ODCs  are  consolidated  to  generate   extend  loans  or  purchase  assets.  
the  Depository  Corporation  Survey.    
  In  this  way,  the  money  deposited  in  the  banks  becomes  the  
We  have  also  seen  how  to  consolidated  the  liabilities  of  the  DCS   instrument  for  lending  by  the  commercial  banking  sector  to  the  
represents  the  concept  of  broad  money.     private  sector.  
   
Finally,  we  have  seen  how  the  financing  flows  to  and  from  the  other   When  banks  extend  loans  using  the  money  in  their  deposits,  they  
sectors  of  the  economy,  reflect  in  the  DC's  balance  sheet.   increase  the  amount  of  money  in  circulation.  When  the  loans  get  
  spent  and  generate  new  earnings,  the  deposits  of  the  private  sector  
  in  the  banking  sector  will  increase  again.  The  lending  activities  of  
  the  banks  increase  the  amount  of  money  in  circulation.  
 
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However,  there  is  an  important  detail  in  this  process.   By  the  process  we  have  just  discussed,  the  bank's  reserves  will  tend  
Banks  have  to  keep  liquid  reserves  to  meet  withdrawal  demands  of   to  be  linked  to  the  total  amount  of  deposits  in  the  system.  
their  customers.    
As  we  have  seen  when  discussing  the  accounts  of  the  ODCs,  banks   We  can  therefore  see  that  there  will  be  a  relationship  between  
will  typically  hold  part  of  their  deposits  in  reserves.   money  and  reserve  money,  such  that  the  money  stock  will  be  equal  
  to  a  multiple  of  reserve  money.  
The  central  bank  requires  that  a  fraction  of  their  reserves  be    
deposited  at  the  central  bank.  Those  are  known  as  required   Let's  look  at  a  simple  example  of  how  money  gets  created.  
reserves  and  the  system  by  which  they  are  required  is  known  as  the   In  a  simplified  model,  the  process  starts  with  an  initial  supply  of  
fractional  reserve  system.  That  means  that  they  are  calculated  as  a   base  money  generated  by  the  central  bank.  In  this  case,  we  assume  
proportion  of  total  deposits  in  the  system.   currency  for  100.  
   
The  others,  which  are  kept  in  excess  of  the  central  bank  regulations,   The  initial  expansion  of  the  base  money  by  the  central  bank  
are  maintained  for  the  bank's  own  prudential  reasons,  to  meet   leads  to  a  subsequent  expansion  by  the  commercial  banks  
withdrawal  demands.   through  the  multiplication  of  resources  deposited  with  them.  
   
The  amount  of  excess  reserves  will  depend  on  how  volatile  are   This  is  made  possible  because  of  each  amount  deposited  
customer  withdrawals?  And,  most  importantly,  what  is  the   only  a  fraction  will  need  to  be  kept  in  reserve,  and  the  rest  will  be  
opportunity  cost  of  keeping  resources  liquid?   lent  out.  
  In  this  case,  part  of  the  money  received  will  be  kept  in  cash  form.  
Typically,  the  central  bank  requires  that  the  bank  hold  a  minimum   Since  we  are  making  an  example  that  the  preference  to  keep  cash  
amount  of  reserves,  but  since  the  reserves  at  the  central  bank  yield   balances  is  5%,  our  example  will  imply  that  5  of  the  100  they  have  
a  very  little  interest,  banks  will  tend  to  hold  very  little  reserves   received  is  kept  in  cash.  The  rest  will  be  deposited  in  the  bank.  
in  excess  of  mandatory  requirements.  This  process  generates  a  link   The  bank  will  hold  some  of  those  deposits  in  reserves.  And  the  rest  
between  the  monetary  base  and  the  money  stock.  As  we  have  seen   will  be  lent  out—that  will  be  the  amount  deposited  minus  the  
from  the  balance  sheet  of  the  central  bank,  base  money  is   reserves.  
comprised  of  reserves  and  currency  outside  banks.    
  The  loan  will  be  used  to  purchase  goods  and  services  and  eventually  
The  total  of  the  currency  in  circulation  plus  the  deposits   will  generate  another  cash  holding,  this  time  of  5%  of  the  amount  of  
determines  the  stock  of  money.   the  loan,  and  another  deposit  in  the  bank.  
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Again,  the  bank  will  keep  a  certain  amount  in  reserves  and  will  loan   And  we  assume  that  the  Central  Bank  buys  $100  worth  of  
out  the  rest.   government  bonds  through  an  open  market  operation.  Therefore,  
  the  monetary  base  will  grow  by  100.  
Again,  the  loan  will  be  used  for  the  purchase  of  goods  and  services.    
Again,  a  part  of  it  will  be  kept  in  the  form  of  cash.   Since  the  reserve  requirement  is  still  10%,  as  in  the  last  example,  we  
And  again,  the  rest  will  be  deposited  in  the  bank,  and  so  on.   will  show  how  the  total  amount  of  money  will  end  up  growing  by  
The  process  will  repeat  itself  after  new  deposits  are  created.   1000.  How  precisely  does  that  work?  
At  the  end  of  the  process,  the  amount  of  deposits  created  will  be  a    
multiple  of  the  original  increase  in  reserve  money.   The  process  goes  like  this:  in  purchasing  100  of  government  bonds,  
We  can  see  how  bank  credit  is  a  major  link  in  the  monetary  policy   the  Central  Bank  generates  an  increase  in  the  monetary  base  of  100.  
transmission  process.   The  banks  can  now  extend  100  worth  of  new  credit.  After  the  loans  
Credit  expansion  results  in  the  expansion  of  the  money  stock.   are  extended,  there  will  be  $100  worth  of  new  deposits  in  the    
  banking  sector.  
Let's  now  take  a  break  and  then  look  at  an  example.    
  Now  the  banks  will  keep  10of  such  deposits  in  reserves  and  then  
  will  extend  the  90  remaining  in  new  credit.  After  the  credit  and  the  
loans  have  been  used,  and  the  goods  and  services  have  been  
VIDEO  10:  Money  Multiplier  
purchased,  there  will  be  90  of  new  deposits  generated  in  the  
 
system.  
Hello  and  welcome  back.  
 
 
And  once  again  the  bank  will  keep  required  reserves,  this  time  9,  
Let's  start  with  a  simple  example  of  how  to  compute  the  money  
then  extend  new  loans  by  81.  The  process  will  then  continue.  
multiplier.  In  this  case,  we  will  use  a  simplified  example.  
We  can  now  show  that  for  an  initial  increase  of  100,  the  total  
 
amount  of  money  will  increase  by  1000.  
We  assume  that  depositors  keep  no  cash,  but  they  deposit  
 
everything  they  earn  in  the  banks.  We  assume  that  banks  only  hold  
How  do  we  compute  this?  Well,  in  the  first  place  there  will  be  
the  required  reserves  and  do  not  keep  any  reserves  buffers  in  
an  initial  increase  in  the  monetary  base  of  100.  The  second  time,  
excess  of  minimum  requirement.  
there  will  be  an  increase  in  deposits,  equal  to  the  increase  in  the  
 
monetary  base  minus  the  reserve  requirement.  The  third  
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time,  there  will  be  an  increase  in  deposits  equal  to  the  initial   can  express  all  the  terms  composing  the  money  multiplier  in  terms  
increase  in  the  monetary  base  minus  the  reserve  requirements,   of  the  ratio  to  deposits.  
twice,  and  so  on,  until  the  process  reaches  its  end  iteration.      
   We  can  then  define  as  C  the  ratio  of  currency  to  deposits,  which  
Now,  what  are  we  looking  at?   denotes  the  general  public  preference  for  holding  cash,  and  then  
Well,  this  looks  a  lot  like  a  Taylor  series  expansion.  Therefore,   we  can  write  and  call  R  the  ratio  of  total  reserves  over  total  deposits  
we  can  now  write...   that  reflects  both  the  mandatory  deserves  requirement  ratio  plus  
  the  excess  reserve  requirement  ratio.  
And  finally  we  know  that  this  is  equal  to  1  over  rr  times  the  initial    
increase  in  the  money  base.  In  our  case,  we  know  that  this  is  10%,   So  that  now  the  money  multiplier  can  be  expressed  as...  
we  know  this  is  100,  and  therefore,  the  total  increase  in  this  stock  of   We  can  now  see  how  the  money  multiplier  can  increase  both  to  an  
money  will  be  equal  to  1000.   increase  in  the  preference  for  holding  cash  or  because  of  the  effects  
  of  some  change  in  the  mandatory  reserve  requirements.  The  
Let's  now  try  to  formally  derive  the  money  multiplier.  We  can  start   Central  Bank,  by  increasing  or  decreasing  the  required  reserves,  can  
with  the  definition  of  the  monetary  base  and  the  stock  of  money.   affect  the  total  money  stock.  
We  have  seen  in  the  previous  parts  of  this  lecture  how  the    
monetary  base  generated  by  the  Central  Bank  is  equal  to  currency    At  the  same  time,  when  banks  decide  how  much  excess  reserves  
plus  reserves  of  the  banks.  We  have  also  seen  that  these  are   they  will  hold,  they  will  also  be  affecting  R.  Any  changes  in  the  
typically  divided  in  required  reserves  and  excess  reserves.   behavior  of  any  of  the  agents  with  respect  to  the  preference  either  
  of  holding  currency  or  holding  reserves  well  then  affect  the  stock  of  
We  know  that  the  general  public  demands  for  money  for   money.  
transactional  purposes,  currency  and  deposits.  We  have  just    
discussed  how  we  have  the  relationship  between  the  amount  of  the   One  final  note  is  that  the  Central  Bank's  control  over  the  stock  of  
monetary  base  and  the  stock  of  money  in  circulation.   money  that  derives  from  its  ability  to  influence  the  money  
  multiplier  is  incomplete,  because  it  can  only  affect  the  part  of  the  
In  particular,  we  can  express  the  total  amount  of  money  in   reserves  under  regulation.  However,  it  can  also  influence  the  
circulation  as  a  multiple  of  the  monetary  base  and  we  will  call  this   preference  for  currency  and  the  preference  for  holding  excess  
multiple  the  money  multiplier.  We  can  then  express  the  money   reserves  by  influencing  the  level  of  the  interest  rate  when  it  
multiplier  as  the  ratio  of  money  to  the  monetary  base,  and  by  the   purchases  or  sells  securities  in  open  market  operations.    
definitions  expressed  above  we  can  write  C  plus  D  over  C  plus  R.  We    
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Let's  see  how  this  theory  works  in  a  numerical  example.   Then,  the  opportunity  cost  of  holding  excess  reserves  will  determine  
  the  level  of  excess  reserves  by  the  private  banks.  
  That  will  be  determined  on  the  liquidity  risk  that  the  banks  face  
vis-­‐a-­‐vis  the  level  of  the  interest  rates  prevailing  in  the  economy,  
VIDEO  11:  Money  Multiplier  –  Example  
and  finally,  the  private  sector  opportunity  cost  of  holding  cash  
 
balances  instead  of  depositing  them  in  the  bank.  
Assume  R  is  15%.  That  is  the  ratio  of  reserves  to  total  deposits.  
 
And  C  -­‐-­‐  the  preference  for  holding  cash  —is  5%.  
If  the  value  of  them  on  the  multiplier  is  not  constant  over  time,  the  
The  money  multiplier,  we  have  just  seen,  will  be  C+1  C+R,  and  
relationship  between  reserve  money  and  the  money  supply  will  be  
therefore,  in  this  case,  5.25.  
weak.  When  the  Central  Bank  estimation  show  that  the  money  
 
supply  is  growing  too  quickly,  the  Central  Bank  can  intervene  by  
Therefore,  if  in  this  case  the  monetary  base  increases  by  100,  the  
reducing  the  monetary  base.  We  have  seen  how  these  operations  
stock  of  money  will  be  expected  to  increase  by  525.  If  we  want  to  
work  when  we  were  discussing  the  balance  sheet  of  the  Central  
extend  these  calculations  to  M2,  the  broad  money  stock,  and  not  
Bank.  
just  the  narrow  money  definition  we  have  been  using  to  derive  the  
 
money  multiplier,  we  have  to  keep  in  mind  that  M2  also  includes  
It  can  sell  assets  through  open  market  operations,  
time  deposits  and  money  market  funds,  as  well  
it  can  increase  the  level  of  mandatory  reserve  requirements  for  the  
as  the  components  of  M1.    
banking  sector,  and  it  can  also  reduce  the  amount  the  Central  Bank  
 
itself  lends  to  the  banks.    
Therefore,  the  multiplier  for  M2  will  include  the  public's  preference  
 
for  having  time  and  savings  deposits,  which  we  typically  denote  as  
By  converse,  if  the  Central  Bank  believes  that  the  money  stock  is  not  
T,  and  the  public's  preference  for  holding  money  market  funds,  
growing  enough,  it  can  inject  liquidity  in  the  system  by  doing  the  
which  we  will  define  as  MMF.  We  can  then  show  that  the  money  
reverse  operations,  in  this  case  purchasing  assets,  lowering  reserve  
multiplier  for  the  broad  money  stock  M2  will  be  equal  to  1  plus  the  
requirements  and  increasing  lending  to  the  banking  sector.  Let's  
preference  for  holding  currency,  the  preference  for  holding  time  
summarize  this  class  by  looking  at  the  components  of  broad  money.  
and  savings  deposit  and  the  preference  for  holding  money  market  
 
funds  over  R+C  just  as  in  the  case  of  M1.    
The  monetary  base  and  the  money  multiplier  together  generate  the  
 
size  of  broad  money.  We  have  seen  the  different  components  of  the  
We  can  now  look  at  the  main  components  of  the  money  multiplier.  
money  multiplier.  We  have  seen  it  depends  on  the  mandatory  
We  have  seen  that  one  of  the  important  components  are  the    
reserve  requirements.  They  are  decided  by  the  Central  Bank.  
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reserve  requirements  and  excess  reserves  of  the  banks,  and  on  the   Finally,  money  provides  a  means  whereby  people  can  store  their  
preference  of  the  public  for  keeping  cash.   earnings  and  transfer  their  purchasing  power  from  the  present  to  
While  the  monetary  base  is  composed  of  those  elements  we  have   the  future.  
been  seeing  in  the  Central  Bank's  balance  sheets,  namely  net    
foreign  assets,  net  claims  on  government,  net  claims  on  the   Therefore,  it  has  to  be  related  to  the  relative  value  of  postponing  
domestic  banks,  and  other  items  net.   consumption  from  today  to  tomorrow.  Such  a  relative  value  is  a  
  function  of  the  rate  of  return  on  money,  compared  with  yields  on  
All  the  operations  of  the  Central  Bank  with  the  government   alternative  assets.  
increase  reserve  money  and  via  the  multiplier  the  money  stock.    
Let's  now  take  a  break.   Hence,  we  expect  the  nominal  money  demand—which  we  will  call  
  Md—to  depend  on  income,  the  level  of  prices,  and  the  opportunity  
  cost  of  holding  money.  
VIDEO  12:  Money  Demand    
  The  higher  is  real  income,  the  more  goods  and  services  people  will  
Money  Demand.   buy.  And  therefore,  the  more  transactions...demand  for  money  
In  this  section,  we  will  talk  about  the  demand  for  money.   increases.  
What  does  make  people  hold  money?    
  Therefore,  the  higher  the  price  level,  the  more  money  you  need  to  
In  the  first  place,  money  is  a  medium  of  exchange.  It  saves  people   buy  a  given  number  of  things,  the  more  the  demand  for  money  
from  having  to  barter  goods  and  evaluate  different  quantities  of   increases.  
different  goods.    
  The  higher  the  interest  rate,  or  the  opportunity  cost  of  holding  
Therefore,  it  has  to  be  in  some  way  related  to  the  amount  of  goods   money,  the  more  attractive  other  interest-­‐bearing  assets  
that  get  exchanged  in  the  economy  during  a  certain  period.   become  as  a  store  of  value.  Therefore,  portfolio  demand  for  money  
  falls.  
In  addition,  it  provides  an  efficient  way  of  expressing  the  value  of    
each  good,  and  therefore  is  the  unit  of  account  for  value.  Therefore,   At  this  point,  we  need  to  make  a  distinction  between  demand  
it  has  to  be  related  to  the  general  level  of  prices  in  the  economy.   for  nominal  versus  demand  for  real  money  balances.  
  Nominal  demand  is  the  demand  for  a  given  number  of  specific  
currency  units,  for  example,  dollars.  
 24

Real  demand  is  the  demand  for  money  expressed  in  terms  of  the   Let's  express  the  money  demand  equation  in  logarithmic  terms.  
goods  and  services  that  money  can  buy.   By  taking  natural  logs,  we  can  write-­‐-­‐  and  then  taking  derivatives-­‐-­‐  
  and  then  taking  derivatives  with  respect  to  time,  we  find  a  
We  usually  specify  the  money  demand  function  in  real  terms   fundamental  relationship  that  links  money  to  prices  and  goods.  
because  we  assume  the  demand  for  nominal  money  balances   As  long  as  the  income  velocity  of  money  is  constant,  the  growth  in  
is  proportional  to  the  price  level.   the  money  supply  beyond  the  growth  in  real  incomes  will  lead  to  
  inflation.  
The  price  elasticity  of  nominal  money  balances  is  unit.    
This  also  implies  that  people  are  free  from  what  is  called  "money   The  higher  the  growth  in  the  money  supply,  the  higher  the  inflation  
illusion".   rate.  
  Velocity  is  one  of  the  most  studied  variables  in  monetary  
The  earliest  monetary  theory,  and  one  of  the  most  influential,   economics.  
is  based  on  the  link  between  the  nominal  stock  of  money,  M,    
and  the  market  value  of  output  that  it  finances.   It  is  a  very  useful  concept  for  a  policymaker.  
  If  v  can  be  predicted  with  confidence,  well,  then  one  can  aim  at  the  
The  so-­‐called  "quantity  equation"  equates  the  stock  of  money  in   level  of  the  money  supply,  which  is  consistent  with  the  attainment  
real  terms  with  real  output,  with  a  proportionality  factor,  k.   of  a  desired  real  growth  and  inflation  rate.  
   
If  k  is  assumed  to  be  constant,  this  expression  provides  the  quantity   A  closer  examination  of  v  reveals  that  velocity  is  not  a  mechanical  
theory  of  money.   link  between  nominal  income  and  the  stock  of  money,  but  rather,  it  
  is  a  concept  very  much  linked  to  the  demand  for  money.  
This  theory  postulates  a  direct  link  between  the  stock  of  money  and   And  in  fact,  velocity  and  money  demand  are  inversely  related.  
the  price  level  whenever  the  economy  is  assumed  to  be  at  full    
employment.   What  does  the  quantity  theory  of  money  predict?  
Thus,  as  long  as  k  remains  constant,  there  is  a  proportional  relation   It  will  predict  that  the  undesired  increase  in  the  stock  of  money  
between  M  and  P.   will  lead  to  higher  inflation  in  the  economy.  
We  call  "v"  the  inverse  of  k,  which  then  becomes  the  number  of   Do  we  find  this  in  the  data?  
times  M  turns  over  in  a  given  period,  financing  P*Y.    
  We  can  check  historical  series  to  see  if  this  relationship  holds.  
We  call  v  the  income  velocity  of  money.    
 25

This  graph  represents  the  average  change  in  the  stock  of  broad   factors  associated  with  the  development  of  the  financial  sector,  
money  over  the  period  2000  to  2012,  as  compared  with  the  average   with  the  increased  access  to  financial  services,  and  with  the  
change  in  the  Consumer  Price  Index  (CPI)  in  the  same  period  on  the   expansion  of  financial  instruments,  has  been  affecting  the  income  
vertical  axis  for  a  large  sample  of  countries.   velocity  of  money  in  countries  across  the  world.  
   
Linear  interpolation  of  the  data  evidences  a  distinct  positive    
relationship  between  the  change  in  the  money  stock  and  the  
VIDEO  13:  Money  Demand  (continued)  
change  in  prices,  which  would  support  the  conclusion  of  the  
 
quantity  theory  of  money.  
Why  do  we  expect  velocity  to  increase?  
 
For  example,  when  demand  for  money  falls.  
The  important  conclusions  that  can  be  derived  from  the  quantity  
That  will  happen  in  a  period  of  high  inflation,  because  people  will  try  
theory  of  money  are  that  the  increase  in  prices  can  be  controlled  by  
to  get  rid  of  their  cash  balances  before  they  depreciate.  
controlling  the  stock  of  money  in  the  economy.  
 
 
Or  in  a  period  when  interest  rates  are  very  high,  and  therefore  the  
In  this  context,  the  central  bank  can  control  the  stock  of  money.  
opportunity  cost  of  holding  money  increases.  
And  we  have  seen  that  if  the  money  multiplier  is  stable,  the  central  
By  contrary,  we  would  expect  velocity  to  decline  if  the  economy  
bank  can  control  the  stock  of  money  by  controlling  the  monetary  
becomes  increasingly  monetized  because  of  financial  deepening.  
base—then,  the  central  bank  will  be  also  able  to  control  inflation  in   This  will  imply  an  increase  in  money  demand.  
the  economy.    
  We  can  also  observe  a  relative  change  in  the  demand  for  the  
We  have  seen  how  the  central  back  can  control  the  monetary  base   different  components  of  the  stock  or  money.  
by  limiting  growth  in  net  domestic  assets  and  net  foreign  assets.    
It  also  follows  from  the  quantity  theory  of  money  that  if  the  central   For  example,  the  increases  in  the  number  of  banks  or  technological  
bank  is  able  to  control  the  stock  of  money,  it  will  also  be  able  to   advances,  such  as  credit  cards,  cash  machines,  and  electronic  
control  the  growth  of  credit  to  the  private  sector.   transfers,  can  raise  velocity  because  it  becomes  easier  to  convert  
  between  money  and  money  substitutes.  
But  is  velocity  really  constant?    
  So  money  demand  for  pure  cash  balances  falls.  
In  recent  years,  we  have  been  observing  that  velocity  is  not  such  a    
stable  variable  as  we  might  imagine.  In  particular,  a  number  of  
 26

The  reduction  of  the  demand  for  cash  implies  that  the  velocity  of   After  discussing  the  quantity  theory  of  money,  let's  discuss  what  
M1  increases,  but  it  is  important  to  note  that  this  shift  has   central  banks  have  been  doing  in  practice.  
generated  also  an  increase  in  the  demand  for  broad  money    
components,  that  is,  instruments  with  a  longer  term.   Concretely,  we  can  find  that  central  banks  across  the  world  seek  to  
Thus  we  would  observe  the  velocity  of  M2  to  fall.   make  consistent  decisions  towards  the  sometimes  conflicting  
  objectives  of  monetary  and  exchange  rate  policies.  In  so  doing,  they  
The  liberalization  of  capital  flows  has  mostly  also  been  associated   implement  four  alternative  monetary  and  exchange  rates  regimes.  
with  a  reduction  of  the  domestic  level  of  interest  rates  and  an    
expansion  of  the  financial  assets,  so  that  the  effects  on  velocity  of   These  can  be  categorized  as:  (1)  regimes  where  the  central  bank  
been  mixed.   targets  monetary  aggregates,  (2)  regimes  where  the  central  bank  
  targets  the  exchange  rate,  (3)  regimes  where  the  central  bank  
The  central  bank  requires  an  accurate  estimation  of  the  demand  for   targets  the  inflation  rate,  and  (4)  eclectic  regimes  where  there  is  no  
money.  However,  if  the  velocity  of  money  changes  because  of   specific  preset  target.  
structural  factors  in  the  economy,  the  central  bank  runs  the  risk  of    
making  a  mistake.   When  a  central  bank  decides  to  target  monetary  aggregates,  they  
  rely  on  the  notion  implied  by  the  quantity  theory  of  money—that  
If  the  central  bank  underestimates  velocity,  that  means  that  the   is,  there  is  a  stable  relationship  between  the  amount  of  money    
demand  for  money  is  actually  lower,  and  it  generates  an  excess   people  will  require,  their  nominal  income,  and  the  level  of  interest  
supply  of  money  in  the  economy.   rates  in  the  economy.  
The  excess  supply  of  money  will  lead  to  higher  inflation  or  will    
increase  the  demand  for  foreign  goods  under  a  fixed  exchange  rate   Central  banks  will  then  seek  to  ensure  that  the  stock  of  money  in  
regime,  and  eventually  will  lead  to  a  depletion  of  foreign  exchange   the  economy  is  consistent  with  the  demand  for  money  so  as  
reserves.   to  avoid  unwanted  increases  in  prices.  
   
If  the  central  bank  over  estimates  velocity  and  therefore  provides   We  have  seen  that  if  the  money  multiplier  is  stable,  the  central  bank  
too  little  money,  the  tight  monetary  stance  will  lead  to  an  increase   will  aim  at  controlling  the  money  supply  by  controlling  the  
in  interest  rates  and  therefore  lower  investment  and  growth  in  the   monetary  base,  where  mm  is  the  money  multiplier  and  includes  the  
economy.   propensity  of  the  public  to  save,  and  the  level  of  required  reserves  
  established  by  the  central  bank.  
 
 27

We  have  also  seen  in  the  previous  part  of  this  lecture  how  the   If  the  central  bank  buys  and  sells  reserves  to  achieve  a  desired  level  
central  bank  can  do  this  through  open  market  operations  and   of  the  exchange  rate,  it  will  no  longer  have  control  over  the  NFA  
setting  the  level  of  required  reserves  for  banks.   part  of  the  balance  sheet.  
  This  will  occur  because  NFA  will  fluctuate  as  much  as  it  is  necessary  
If  you  remember  from  the  first  part  of  this  lecture,  M2  will  be  equal   to  reach  a  desired  level  of  the  exchange  rate.  
to  the  sum  of  the  NDAs  and  the  NFAs  of  the  depository  corporations   Therefore,  the  central  bank  will  need  to  conduct  open  market  
sector.  When  targeting  monetary  aggregates,  the  central  bank  can     operations  to  sterilize  undesired  increases  in  NFA  with  a  decline  in  
act  through  open  market  operations  and  sterilize  any  unexpected   NDA,  so  as  to  keep  the  monetary  base  at  the  desired  level.  
increases  in  its  own  NDAs  or  NFAs,  so  as  to  achieve  a  monetary  base    
consistent  with  the  desired  level  of  M2  in  circulation.   However,  it  tends  to  be  often  the  case  that  the  sterilization  
  operation  may  not  be  fully  effective.  
This  used  to  be  the  main  for  framework  for  monetary  policy    
operations  in  the  '70s  and  '80s  in  industrialized  countries,  and  to   And  at  times,  this  will  lead  to  a  case  of  losing  fully  or  partially  the  
these  days  a  number  of  countries  still  rely  on  it.   control  of  the  monetary  base.  
   
The  full  list  of  such  countries  can  be  found  in  the  IMF's  publication   Exchange  rate  targeting  regimes  do  not  allow  central  banks  to  
on  exchange  rate  arrangements  and  exchange  restrictions.   pursue  any  other  policy  than  exchange  rate  stabilization  because  
In  exchange  rate  targeting  regimes,  the  central  bank  uses  the   the  level  of  the  domestic  interest  rates  can  never  diverge  from  that  
exchange  rate  as  a  nominal  anchor  to  achieve  price  stabilization.   of  foreign  rates.  
   
In  this  framework,  the  central  bank  will  buy  and  sell  foreign  reserves   Central  banks  that  pursue  inflation  targeting  regimes  use  the  
to  ensure  that  the  exchange  rate  depreciation  is  as  close  as  possible   inflation  forecast  as  the  nominal  anchor.  
to  0.  Under  fixed  exchange  rate  arrangements,  the  central  bank    
commits  to  buy  and  sell  foreign  exchange  at  a  targeted  exchange   They  will  enact  open  market  operations  to  ensure  that  the  
rate.   prevailing  level  of  domestic  interest  rates  is  consistent  with  the  pre-­‐
  announced  inflation  target.  
Countries  that  follow  this  framework  are:  Denmark,  Saudi  Arabia,  et    
cetera.  As  we  have  seen,  the  monetary  base  is  equal  to  the  NFA  and   Under  this  regime,  the  exchange  rate  is  flexible  and  NFA  do  not  
the  NDA  of  the  central  bank.   change,  126  00:08:09,945  -­‐-­‐>  00:08:20,570  but  the  central  bank  will  
  target  a  level  of  NDAs,  and  therefore  of  the  monetary  base,  such  
 28

that  they  are  consistent  with  achieving  the  targeted  level  of  the   Then  we  derived  the  equation  for  the  quantity  theory  of  money  
interest  rate.   that  establishes  that  the  demand  for  real  money  balances  will  be  
  proportional  to  the  level  of  income.  
Examples  of  inflation  targeting  regimes  are  New  Zealand,  Chile,  the    
UK,  the  Czech  Republic,  Poland,  Romania,  and  many  other   This  predicts  that  an  undesired  increase  in  the  stock  of  money  will  
countries.   lead  to  higher  inflation  if  the  income  velocity  of  money  is  constant.  
Finally,  there  are  countries  that  don't  use  a  specific  anchor  to    
achieve  price  stability,  but  adjust  policy  instruments  to  pursue   Finally,  we  have  discussed  different  factors  that  may  change  the  
economic  growth  and  low  unemployment.   income  velocity  of  money  and  the  risks  the  central  banks  face  if  
  they  mis-­‐estimate  the  income  velocity  of  money.  
Examples  of  these  are  the  US,  the  Euro  area,  Japan,  India,  and  many    
others.    
Historically,  countries  have  been  shifting  towards  inflation  targeting   VIDEO  14:  Selected  Issues  
and  eclectic  regimes  as  capital  accounts  have  been  liberalized  and    
central  banks  have  been  pursuing  policy  objectives  of  growth  and   In  the  last  part  of  this  lecture,  we  will  cover  specific  topics  that  are  
unemployment.   relevant  for  monetary  analysis  and  monetary  policy  decisions.  
  Namely,  these  are  the  presence  of  seigniorage,  foreign-­‐capital  
In  particular,  we  can  see  that  in  advanced  countries,  the  incidence   inflows,  and  vulnerabilities  in  the  financial  sector.  
of  eclectic  regimes  has  increased  significantly  in  recent  times,  while   The  first  of  our  topics  is  seigniorage.  
in  emerging  market  countries  it  has  been  the  inflation  targeting    
regimes,  the  one  that  has  experienced  the  widest  increase  in   Seigniorage  is  the  rent  to  the  central  bank  that  stems  from  the  
countries  across  the  world.   privilege  of  being  the  sole  issuer  of  the  currency.  
   
What  have  been  the  main  concepts  we  have  been  discussing  in  this   It  extends  from  the  fact  that  the  cost  of  printing  currency  
class?   is  lower  than  the  value  of  the  assets  of  the  central  bank.  
In  the  first  place,  we  have  discussed  for  what  purpose  people  hold    
money,  and  established  that  the  level  of  income,  the  level  of  prices,   This  feature  has  important  implications  for  monetary  policy  
and  the  level  of  the  interest  rates  will  be  important  determinants  of   decisions,  To  explain  this  property,  let's  assume  that  in  a  country  
the  demand  for  money.   money  demand  increases  at  the  same  rate  as  GDP,  as  we  would  
  expect  from  the  quantity  theory  of  money.  
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Let's  assume  the  GDP  grows  at  4%  per  year.   The  second  of  our  topics  is  capital  inflows.  
So,  to  maintain  the  prices  stable,  the  central  bank  has  to  increase   In  recent  years,  capital  accounts  of  countries  across  the  world  
money  supply  by  4%  per  year.   have  been  liberalized  and  capital  can  freely  flow  across  national  
Therefore,  the  central  bank  can  increase  the  monetary  base  in  the   frontiers,  providing  financial  intermediation  services  among  
same  proportion  without  generating  inflation.   countries  similar  to  those  that  banks  provide  for  savers  and  
Given  a  stable  money  multiplier,  this  implies  that  the  central  bank   investors  within  the  country.  
will  be  expanding  its  balance  sheet  by  4%  a  year  at  no  economic    
cost  beyond  that  of  printing  money.   Capital  flows  strengthen  the  link  between  domestic  economic  
The  other  component  of  seigniorage  is  the  inflation  tax.   policies  and  the  balance  of  payments.  
  As  the  world  capital  markets  have  become  increasingly  integrated  in  
We  typically  talk  about  the  inflation  tax  in  the  context  of  financing   the  past  two  decades,  so  have  domestic  monetary  policies  and  
of  the  public  deficit.  If  the  government  requires  the  central  bank  to   monetary  developments  in  foreign  countries.  
finance  its  deficit,  the  central  bank  will  have  to  print  money.    
And  when  it  does  so,  according  to  the  quantity  theory  of  money,   Under  perfect  capital  mobility,  the  slightest  difference  between  
it  will  generate  an  increase  in  prices.   interest  rates  prevailing  in  the  domestic  and  foreign  capital  markets  
  provokes  a  very  large  capital  flow.  
Such  inflation  will  become  a  tax  on  the  public  because  by  printing    
money  the  central  bank  reduces  the  value  of  real  money   Therefore,  the  tightening  of  monetary  policy  stance  in  a  country  
balances  of  the  general  public.   will  induce  capital  inflows.  
   
More  in  general,  inflation  reduces  the  real  value  of  the  liabilities  of   When  countries  seek  to  maintain  their  exchange  rate  fixed,  the  
both  the  government  and  the  central  bank.   capital  inflows  following  an  attempt  by  the  central  bank  to  tighten  
This  constitutes  revenue  for  the  central  bank.   monetary  policy  will  force  the  central  bank  to  intervene  in  the  
  foreign-­‐exchange  markets  in  order  to  prevent  the  domestic  
For  example,  if  the  monetary  base  is  19.25%  of  GDP,  a  10%  inflation   currency  from  appreciating.  
rate  will  reduce  liabilities  in  real  terms  by  1.9%  of  GDP.    
  The  increase  in  the  net  foreign  assets  will  offset  any  initial  money  
If  the  velocity  of  money  has  not  changed,  the  central  bank  can  now   contraction,  forcing  domestic  interest  rates  back  down  to  the  level  
issue  1.9%  of  GDP  in  base  money.  This  is  the  inflation  tax  collected   in  foreign  markets.  
by  the  central  bank.    
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When  countries  leave  their  exchange  rate  to  float  freely  following  a   It  is  important  for  central  banks  making  monetary-­‐policy  decisions  
tightening  of  monetary  policy,  the  central  bank  will  not  intervene  in   to  have  an  assessment  of  the  health  of  the  financial  sector,  because  
foreign-­‐exchange  markets.   monetary  policy  decisions  will  have  a  direct  effect  on  the  balance  
  sheet  of  the  banks  and  may  weaken  banks'  financial  positions.  
This  implies  that  the  net  foreign  assets  will  not  change,  but  the    
domestic  currency  will  appreciate  vis-­‐a-­‐vis  the  foreign  currency.   When  we  talk  about  "risks"  in  the  financial  sector,  we  think  mainly  
This  will  tend  to  increase  the  domestic  demand  for  foreign  goods   about  four  types.  In  the  first  place,  we  find  liquidity  risk.  Liquidity  
and  generate  a  deterioration  of  the  current  account  deficit  which   risk  the  risk  that  an  unexpected  shock  yields  an  unanticipated  
will  be  financed  by  the  capital  flows.   withdrawal  of  deposits.  
In  this  context,  the  link  between  the  money  supply  and  the  balance   Liquidity  risk  is  intrinsic  to  the  banking  business.  
of  payments  is  broken  and  the  central  bank  regains  control  over   It  derives  from  the  function  of  transforming  short-­‐term  liabilities,  
money  supply.   such  as  deposits,  into  long-­‐term  assets.  
  Therefore  at  no  moment  in  time  can  banks  repay  all  of  their  
In  practice,  central  banks  are  often  weary  of  allowing  the  exchange   liabilities.  
rate  to  appreciate  too  much  because  of  the  potential  adverse    
consequences  on  the  external  position.   By  nature  of  the  banking  business,  it  is  based  upon  the  assumption  
  that  people  will  not  need  to  withdraw  all  of  their  deposits  at  once.  
In  periods  of  heavy  capital  inflows,  most  countries  have  responded   To  guard  against  such  events,  banks  are  required  to  hold  mandatory  
by  undertaking  a  combination  of  actions.   reserves  at  the  central  bank.  
   
These  have  involved:  (1)  a  partial  intervention  to  buy  some  of  the   And  in  general  they  also  hold  extra  liquidity  buffers,  particularly  in  
capital  inflow,  but  allowing  some  nominal  exchange-­‐rate   those  countries  where  liquidity  shocks  are  high  and  volatile.  
depreciation;  (2)  a  partial  sterilization  of  the  increase  in  net  foreign    
assets  so  as  to  offset  part  of  the  impact  of  the  increase  in  NFAs   In  the  second  place,  we  find  exchange  rate  risk.  Exchange  rate  risk  
on  the  monetary  base;  (3)  some  increase  in  the  monetary  base  and   on  banks'  balance  sheets  stems  from  the  potential  losses  deriving  
inflation  and,  consequently,  some  real  exchange-­‐rate  appreciation.   from  the  revaluation  of  assets  and  liabilities  following  a  change  in  
  the  value  of  the  domestic  currency  vis-­‐a-­‐vis  the  foreign  currency.  
Let's  now  talk  briefly  about  the  main  vulnerabilities  in  the  financial    
sector  and  how  these  are  addressed  by  the  banks.   As  we  have  seen  in  the  class  on  the  depository  corporations  sector,  
 
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if  the  net  open  position  in  foreign  capital  is  negative,  when  the   There  are  number  of  micro-­‐  and  macroeconomic  factors  that  
exchange  rate  depreciates,  banks'  losses  from  the  revaluation  of   influence  the  probability  of  repayment  of  loans.  
liabilities  will  exceed  the  gains  from  the  revaluation  of  assets.    
Therefore  balanced  net  open  positions  will  minimize  such  risk.   For  example,  the  point  of  the  business  cycle  which  the  economy  is  
  at  and  the  corresponding  level  of  unemployment.  
Should  the  exchange  rate  have  a  depreciating  trend,  the  banks   Both  will  influence  the  probability  that  people  will  be  able  to  repay  
would  benefit  from  a  positive  net  open  position.   their  loans.  There  are  a  number  of  other  factors  that  also  need  to  be  
  considered.  
The  third  important  risk  that  banks  carry  on  the  balance  sheet  is  the    
risk  of  losses  following  the  re-­‐pricing  of  banks'  assets  and  liabilities   For  example,  if  the  debt-­‐service  burden  of  the  household  is  very  
following  a  change  in  the  interest  rates.   sensitive  to  the  level  of  interest  rates  because  loans  have  floating  
  rates,  or  if  they  are  very  sensitive  to  the  level  of  the  exchange  rate  
Remember  that  banks'  assets  are  typically  long-­‐term  and  the   because  loans  are  denominated  in  foreign  currency.  
income  stream  can  be  fixed.    
  All  these  factors  affect  the  probability  of  repayment  of  bank  loans.  
By  contrary,  banks'  liabilities  are  typically  short-­‐term  and  generate   Banks  hedge  against  credit  risk  by  setting  aside  provisions  to  face  
payments  depending  on  the  prevailing  level  of  interest  rates  in  the   losses  from  the  occurrence  of  defaults.  
economy.  Therefore  banks  can  suffer  losses  or  gains  depending  on   The  size  of  the  provisions  will  depend  on  the  likelihood  of  the  loss  
the  interest  rate  structure  of  their  balance  sheets—fixed  versus   and  the  historical  loss  experience.  
floating.   To  summarize,  central  banks  should  analyze  these  risks  on  balance  
  sheets—liquidity  risk,  exchange  rate  risk,  interest  rate  risk,  
Banks  hedge  interest  rate  risk  by  building  portfolios  of  assets  to   and  credit  risk—before  they  make  monetary  policy  decisions  
match  the  interest  rate  structure  of  their  liabilities.   because  a  significant  vulnerability  the  banking  sector  to  one  or  all  of  
  these  risks  may  cause  large  losses  for  the  banking  sector  following  
And  finally,  the  largest  risk  typically  on  balance  sheets  of  traditional   a  decision  of  the  central  bank.  
depository  corporations  is  credit  risk.    
  Let's  take  a  step  aside  now  to  review  what  we've  learned  in  this  
What  is  credit  risk?   class.  
That  is  the  risk  that  a  loan  will  not  be  repaid.    
We  have  learned  how  to  read  the  balance  sheets  of  the  central  bank  
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and  of  the  other  depository  corporations.   COUNTRY  CASE  VIDEO  1  

   
We  have  also  seen  how  the  balance  sheets  of  the  central  bank  and   In  the  next  and  following  set  of  questions  you  will  be  working  on  the  
that  of  the  other  depository  corporations  are  consolidated  to  draw   survey  of  financial  corporations  for  Macronia.  
analysis  on  the  evolution  of  the  monetary  aggregates  in  the   And  actually  in  the  set  of  questions  that  immediately  follow  this  
economy.   tutorial  video,  you  will  only  work  on  the  balance  sheet  of  the  central  
  bank  and  that  of  other  depository  corporations.  
We  have  discussed  how  the  central  bank  can  control  the  amount  of    
money  in  circulation  by  controlling  the  monetary  base  if  money   We  will  then  see  how  to  consolidate  the  two  to  obtain  the  survey  of  
multipliers  are  stable.   financial  corporations  in  the  next  tutorial  video.  
   
We  have  also  discussed  how  the  central  bank  needs  to  analyze   So  let's  go  back  to  the  central  bank  and  let's  now  start  to  complete  
closely  money  demand  before  making  decisions  on  monetary  policy.   the  balance  sheet  of  the  central  bank.  
In  particular,  we  have  seen  how,  according  to  the  quantity  theory  of    
money,  an  excess  supply  of  money  will  generate  inflation.   Let's  start  from  the  liability  side.  
   
Finally,  we  have  discussed  a  set  of  issues  that  the  central  bank  will   Actually,  to  complete  the  table  and  answer  the  following  questions,  
have  to  take  into  consideration  before  making  monetary  policy   we  suggest  that  you  follow  exactly  the  order  in  which  those  
decisions,  namely,  the  amount  of  seigniorage  it  can  extract,  the   questions  are  posed.  
impact  of  its  decision  on  capital  inflows,  and  the  health  of  the    
financial  sector.   So  let's  now  start  from,  as  I  suggested,  computing  the  liabilities.  
  Well,  the  monetary  base  is  simply  equal  to  the  currency  in  
circulation  plus  liabilities  to  other  depository  corporations  which  
gives  a  value  of  2,218.  
 
In  general,  information  about  net  foreign  assets  are  obtained  fairly  
easily.  In  most  cases  to  obtain  net  domestic  asset,  if  you  look  at  a  
balance  sheet  of  the  central  bank  you  might  need  to  do  some  
rearrangement.  
So  it's  generally  easy  to  compute  this  simply  as  the  value  of  the  
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liabilities.   corporations,  minus  the  claims  on  the  rest  of  the  private  sector,  
  minus  the  monetary  stabilization  bonds.  
So,  I'm  sorry.  Set  it  equal  to  the  values  of  the  liabilities  minus  the    
values  of  net  foreign  assets.   And  this  would  deliver,  indeed,  the  same  number  that  you  obtained  
  before.  
Why  are  we  doing  this?    
Simply  because  let's  remember  the  sum  of  net  foreign  assets  and   For  the  balance  sheet  of  other  depository  corporations  you  would  
net  domestic  assets  is  equal  to  the  liabilities,  so  the  monetary  base.   do  exactly  the  same  thing.  
So  if  you  have  the  monetary  base  and  net  foreign  asset,  it  is  very    
straightforward  to  compute  net  domestic  asset.   So  you  would  start  from  computing  your  total  deposit  as  the  sum  of  
  transferrable  deposits  and  other  deposits.  You  now  move  to  the  
As  a  next  step,  you  would  compute  all  of  these  components  of  net   asset  side  and  you  will  compute  the  net  domestic  assets  as  the  
domestic  assets.   difference  between  deposits  and  net  foreign  assets.  
   
In  particular,  let's  compute  the  net  claims  on  the  public  sector.   And  finally,  again,  you  can  compute  other  items,  net  in  two  ways.  
And  these  are  equal  simply  to  the  net  claims  on  the  general   You  can  compute  it—well,  let's  start  from  the  second  way  as  net  
government  plus  the  net  claims  on  the  rest  of  the  public  sector.  OK?   domestic  asset,  minus  net  claims  on  the  general  government,  minus  
And  the  result  here  is  minus  86.   net  claims  on  the—the  central  bank,  minus  net  claims  on  the  public  
  sector,  minus  the  claims  on  the  rest  of  the  private  sector.  
Now  to  compute  other  items,  net,  you  may  actually  follow  two    
ways.   And  you  would  obtain  minus  3,442.  
  And  actually  let's  notice  that  this  is,  if  you  highlight  all  of  the  three  
You  can  either  compute  either  items  net  as  a  sum  of  its  sub   cells  below,  this  is—and  you  find  it  down  below  here—exactly  the  
components,  shares  and  other  equities  plus  other  items,  net.   sum  of  these  three  numbers.  So  of  course  this  is  a  balance  sheet,  
  so  numbers  and  summations  should  all  square.  
Or  you  basically  might  use  the  fact  that  net  domestic  asset  must  be      
a  summation  of  all  of  its  sub  components  so  that  you  can  compute  
other  items  net  simply  as  net  domestic  asset,  minus  net  claims  on  
the  public  sector,  minus  the  claims  on  other  depository  
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COUNTRY  CASE  VIDEO  2   And  once  you  have  these  two  elements,  you  can  simply  sum  up  the  
  three  sub-­‐components  of  broad  money.  
In  the  following  set  of  questions,  you  will  still  be  working  with  the    
table  "Macronia:  Survey  of  Financial  Corporations,"  the  one  you   So  currency  in  circulation,  plus  deposits,  plus  other  central  bank  
have  been  working  with  in  the  previous  questions.   liabilities  accounted  as  broad  money,  which  has  been  provided  
  directly  to  you.  
But  you  will  now  switch  to  the  bottom  of  the  table  and  be  asked  to    
complete  the  survey  of  financial  corporations.   You  don't  have  to  bother  computing  that.  
  And  you  can  obtain  broad  money.  
So  as  usual,  to  do  that,  let  me  start  by  demonstrating  how  you    
would  do  the  same  questions  that  you  have  to  do  for  2012,  but  for   Let's  now  move  to  the  upper  part  of  this  table.  
2011.   And  let's  compute,  reconstruct,  all  of  the  assets  of  the  financial  
  corporations.  
Let's  start  by  completing  the  survey  of  financial  corporations.    
And  let's  start  by  computing  broad  money.   Let's  start  from  net  foreign  assets.  
  Net  foreign  assets  would  simply  be  equal  to  the  sum  of  the  net  
So  let  me  delete  all  of  these  numbers  and  reconstruct  them.   foreign  assets  of  the  central  bank  plus  the  net  foreign  assets  of  
  other  depository  corporations.  
So  let's  start  by  the  components  of  broad  money.    
Currency  in  circulation  would  be  equal  to,  if  you  go  up  above,  the   Once  you  have  done  that,  you  can  now  compute  net  domestic  
currency  in  circulation  from  the  central  bank  balance  sheet,  743,  of   assets.  
course,  minus  any  currency  which  other  depository  corporations  are    
holding.   And  again,  the  strategy  here  would  be  simply  to  compute  net  
  domestic  assets  as  the  difference  between  broad  money  and  net  
This  currency,  this  197,  is  actually  within  the  broad  set  of  financial   foreign  assets.  
corporations.  So  it  is  not  counted  as  currency  outside  of  the    
financial  corporations  of  that  set.  Deposits  is  simply  equal  to  the   At  this  point  we  can  start  building  up  all  of  the  sub-­‐components  of  
deposits  of  other  depository  corporations.   net  domestic  credit.  
   
In  particular,  let's  start  from  net  claims  on  the  public  sector.  
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And  let's  start  from  these  two  sub-­‐components  of  it,  the  net  claims   So  for  shares  and  other  equity,  we'd  actually  take  those  of  the  other  
on  the  general  government,  which  would  be  the  sum  of  the  net   depository  corporations,  plus  those  shares  and  other  equity  of  the  
claims  on  the  general  government  from  the  central  bank,  plus  the   central  bank.  
net  claims  on  the  general  government  of  other  depository   And  we  obtain  minus  117.  
corporations.    
  For  other  liabilities  excluded  from  broad  money,  we  would  take  
Similarly,  we  can  compute  the  net  claims  of  the  entire  set  of   these  items  simply  from  that  of  other  depository  corporations.  
financial  corporations  as  the  sum  of  net  claims  on  the  rest  of  the   And  we  can  now  see  that  the  sum  of  these  three  is  exactly  minus  
public  sector  by  the  central  bank,  plus  the  claims  on  the  rest  of  the   2,597.  In  this  way,  we  have  reconstructed  the  entire  survey  of  
public  sector  of  other  depository  corporations.  And  we  obtain  98.   financial  corporations.  
   
If  we  now  sum  these  two,  we  can  obtain  the  net  claims  on  the    
public  sector,  943.  At  this  point,  we  can  compute  the  claims  on  the  
COUNTRY  CASE  VIDEO  3  
rest  of  the  private  sector.  
 
 
You  will  now  be  constructing  some  indicators  from  the  monetary  
And  these,  again,  would  be  those  claims  on  the  rest  of  the  private  
accounts.  
sector  from  the  central  bank,  plus  those  claims  on  the  rest  of  the  
So  you  would  be  working  with  the  table  called  "Macronia  Monetary  
private  sector  of  other  depository  corporations.  And  so  we  would  
Accounts  Indicators."  
obtain  1,072.  If  we  now  sum  up  the  net  claims  on  the  public  sector  
 
and  the  claims  on  the  rest  of  the  private  sector,  we  will  obtain  net  
In  this  table,  you  are  asked  basically  to  compute  the  first  set  of  
domestic  credit.  
indicators,  which  simply  relate  to  the  growth  of  the  money  
 
aggregates.  
At  this  point,  again,  there  are  two  ways  in  which  you  can  
 
compute  other  items,  net.  One  would  be  simply  by  taking  the  net  
For  the  growth  of  money  aggregates,  that  is  actually  fairly  simple.  
domestic  assets  and  subtracting  the  net  domestic  credits.  
You  would  have  to  take—let  me  construct  that  growth  for  net  
 
foreign  assets—you  would  actually  have  to  compute  the  percent  of  
The  other  one  would  simply  be  to  sum  up  the  sub-­‐components.  
change,  for  example,  in  this  specific  case  in  net  foreign  assets.  
Let's  actually  construct  these  components  and  simply  check  that  the  
 
sum  of  the  sub-­‐components  is  equal  to  other  items,  net  that  we  
have  just  calculated.  
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So  you  take—I'm  sorry,  I  forgot  to  put  here  equal  to;  you  might  also   Some  of  them  are  fairly  easy.  For  example,  monetary  base  to  GDP.  
want  to  open  a  parentheses—this  would  be  equal  to  the  net   For  others,  let's  suppose  credit  to  deposit,  you  simply  have  to  take  
foreign  assets  at  the  end  of  the  year  divided  by  the  net  foreign   the  relevant  variable,  in  this  case  this  would  be  net  claims  on  the  
assets  at  the  end  of  the  previous  year  minus  1.  All  of  that  multiplied   private  sector,  and  divide  it  by,  in  this  case,  deposits,  and  then  you  
by  100.  And  you  will  be  able  to  reconstruct  minus  18%.   multiply  everything  by  100,  and  you  are  able  to  reconstruct  this  
  118.9.  
So  the  calculations  for  all  of  the  other  rate  of  growth  is  the  same.    
Let  me  now  maybe  illustrate  how  to  compute  the  contribution  to   Maybe  another  interesting  variable  that  you  might  want  to  compute  
the  growth  of  broad  money  of  some  of  these  specific  aggregates.   is  velocity.  And  to  compute  velocity,  you  would  actually  take  
  nominal  GDP.  And  you  divide  it.  So  you  divide  and  open  a  
So  let's  compute  how  the  growth  in  net  foreign  asset  contributed  to   parentheses,  maybe  open  two  parentheses,  by  the  average  broad  
the  growth  of  broad  money.   money.  
In  this  case,  we  would  basically  have  to  compute  the  difference  in   You  can  compute  the  average  broad  money  simply  by  taking  broad  
net  foreign  asset.   money  at  the  end  the  current  year,  plus  broad  money  at  the  end  of  
  the  previous  year,  close  parentheses,  and  divide  by  2.  That's  an  
Again,  net  foreign  asset  at  the  end  of  the  year  minus  net  foreign   approximation,  of  course,  but  it's  a  fairly  valid  one.  And  you  are  able  
asset  at  the  end  of  the  previous  year,  all  of  that  within  parentheses,   to  compute  velocity  as  2.  
divided  by  the  stock  of  broad  money  at  the  end  of  the  previous  
period,  all  of  that  multiplied  by  100.  
 
And  you  will  be  able  to  reconstruct  this  minus  4.3%.  
Let  me  illustrate  that  again  for  another  aggregate,  which  is  net  
domestic  credit.  
 
Again,  that  would  be  the  difference  in  net  domestic  credit  within  
two  consecutive  end  of  years,  divided  by  the  stock  of  broad  money  
at  the  end  of  the  previous  period,  all  of  that  multiplied  by  100.  
And  you  obtain  here  14.1%.  
 
Finally,  you  will  be  asked  to  compute  other  selected  indicators.