Monetary and credit policy: tutorial 9786010430105

Table of contents :
ISBN 978-601-04-3010-5 © Nurgazina А.М., Assilova А.S., 2017
© Al-Farabi KazNU, 2017
Exchange rate targeting can make it possible to quickly and effectively decrease a high level of inflation, which is important during crisis periods. Such a regime increases the transparency and clarity of the central bank’s monetary policy. If the na...
Targeting of the foreign exchange regime in individual countries (Chile, Brazil, Columbia, Tunisia) was conducted by establishing goals for the real exchange rate.
The experience of Chile and Tunisia was successful in doing this, which reduced the level of inflation considerably. In Chile, during the period of applying a regime of targeting a benchmark for the real exchange rate, the level of inflation decreased...
A key shortcoming of forex exchange rate targeting is the impossibility of pursuing an independent monetary policy in free mobility of capital and the complexity of responding to internal shocks. For example, an increase in interest rates in Germany i...
Risks of speculative attacks on their national currencies are another problem for countries targeting forex exchange rate. Speculative attacks in September 1992 on the currencies of countries pegged to the German mark exchange rate can serve as an exa...
Strategies of currency pegging and dollarization can be considered the most popular strategies reducing currency regime risks.
Currency pegging assumes that the domestic currency is backed 100% by foreign currency, and the central bank establishes a fixed exchange rate and is ready at the request of the population to exchange domestic currency at this exchange rate.
The advantages of currency pegging are control of the money supply and also a stricter obligation of the central bank to adhere to the fixed exchange rate and thus in short time periods help to decrease inflation and reduce speculative attacks on the ...
Argentina’s experience is interesting, which abandoned the currency peg to the US dollar in 2002. In the initial stage, this regime enabled the country to decrease inflation significantly (from 800 percent to 5 percent) and accelerate economic growth ...
Another method of solving the problem of non-transparency of exchange rate targeting is dollarization, i.e., adopting a hard currency like the US dollar as the country’s currency. The main advantage of dollarization is precluding the possibility of sp...
In addition to the advantages, exchange rate targeting has a number of serious shortcomings. The need to maintain the exchange rate in the event of speculative attacks can lead to a significant decrease in the level of gold and foreign exchange reserves.
In conditions of mobility of capital, fixing the exchange rate takes away the possibility of pursuing an independent monetary policy and, consequently, to react to internal shocks of the economy. The nature of the central bank’s monetary policy will t...
Establishing exchange rate goals is aimed at solving problems in a short time period. The influence of a stable exchange rate on long-term trends is not welldefined, since the stability of the nominal exchange rate does not ensure stability of the rea...
In the 1970s, the monetary targeting regime gained special popularity among the central banks of developed countries such as Great Britain, Canada, Japan, Germany, Switzerland, and the US.
Monetary targeting is often used in countries with a transitional economy to curb high inflation. The main advantage of monetary targeting compared to foreign exchange targeting is that it provides the central bank extensive opportunities to pursue mo...
In addition, this strategy is characterized by great flexibility in adjusting monetary policy. The result of measures taken by the central bank is manifested almost immediately. The central bank directly influences money supply and has the ability to ...
However, one can single out a number of objective reasons making it impossible to use this monetary policy receive by central banks.
All the advantages cited above depend on whether or not a strong and stable link exists between the strategic target variable, for example, and the level of inflation and the chosen monetary aggregate. Otherwise, having achieved the intermediate monet...
In addition, it often does not appear possible to obtain and estimate of the demand for money in countries with a transitional economy. Furthermore, the dependence of the national economy on the foreign economic situation increases the likelihood of e...
The complexity of determining a change in the velocity of money, the structure of money supply and the money multiplier, the volatility of money velocity, and the demand for money in the short term, especially taking into account its susceptibility to...
Central banks practicing the monetary targeting regime have achieved various successes in ensuring price stability. Among developed countries, Germany has demonstrated the greatest successes in monetary targeting.
The National Bank of Kazakhstan had experience in conducting monetary aggregate targeting prior to 2000. The main reason for abandoning this regime was its ineffectiveness. The rate of grow of the monetary base did not correspond to the dynamics of in...

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AL-FARABI KAZAKH NATIONAL UNIVERSITY

A. M. Nurgazina A. S. Assilova

MONETARY AND CREDIT POLICY Tutorial Stereotypical publication

Almaty «Qazaq University» 2020

Monetary and Credit Policy

UDC 336 (075) LBC 65.26 я 73 N 94 Recommended for publication by the decision of the Higher School of Economics and business, RISO of the Al-Farabi Kazakh National University (protocol № 3 dated 07.12.2017) Rewiers: doctor of economic sciences, professor A.A. Adambekova candidate of economic sciences, associate professor A.K. Tussayeva D.A. Sadykhanova

Nurgazina A.M. N 94 Monetary and credit policy: tutorial / А.М. Nurgazina, A.S. Assilova. – Ster. pub. – Almaty: Qazaq University, 2020. – 266 p. ISBN 978-601-04-3010-5 The tutorial covers topics related to the development and implementation of monetary policy, the activities of central banks, the classification of monetary instruments, conditions and procedures for conducting open market operations. To improve study outcomes, the tutorial contains questions for self-monitoring, tasks, test questions and attachements. The presented educational material allows to form theoretical knowledge and practical skills in the field of monetary policy. The tutorial is recommended for students and undergraduates studying on financial and economic specialties, and it can also be used to improve the skills of financial market professionals.

UDC 336 (075) LBC 65.26 я 73 © Nurgazina А.М., Assilova А.S., 2020 © Al-Farabi KazNU, 2020

ISBN 978-601-04-3010-5

2

Introduction

CONTENT

LIST OF ACRONYMS ............................................................................. 5 INTRODUCTION ..................................................................................... 6 I. 1.1.

1.2. 1.3. 1.4. II. 2.1. 2.2.

2.3. 2.4.

III. 3.1. 3.2. 3.3.

BASICS OF MONETARY AND CREDIT RELATIONS .............. 8 Theoretical Basics and Historical Development of Monetary and Credit Relations .................................................... 8 1.1.1. Essence of the Monetary and Credit Policy ........................... 8 1.1.2. Historic development of the Money Theory .......................... 13 Basics of the Monetary and Credit Regulation ................................ 24 Subjects of Money and Credit Market ............................................. 28 Main Indicators of Money Market ................................................... 33 MONETARY AND CREDIT POLICY MECHANISM ................. 39 Central banks activity ...................................................................... 39 Directions of the Monetary and Credit Policy.................................. 49 2.2.1. Priorities of the Monetary and Credit Policy.......................... 55 2.2.1. Regimes of the Monetary and Credit Policy .......................... 55 Instruments of the Monetary and Credit Policy ............................... 61 The Implementation of Monetary Policy under the Influence of External Factors ........................................................................... 68 MONETARY AND CREDIT POLICY OF THE REPUBLIC OF KAZAKHSTAN ........................................... 75 Main Particularities of the Monetary and Credit Policy of the Republic of Kazakhstan ............................................................. 75 Analysis of the Effectiveness of Monetary Policy Instruments........ 86 Gold And Foreign Currency Reserves Investment Management ..... 95

CONCLUSION ......................................................................................... 103 GLOSSARY .............................................................................................. 103 TASKS ...................................................................................................... 104 CASE STUDY ........................................................................................... 106 3

Monetary and Credit Policy SAMPLE EXAM QUESTIONS ................................................................ 125 TESTS ....................................................................................................... 128 REFERENCES ......................................................................................... 171 Attachment 1.............................................................................................. 174 Attachment 2.............................................................................................. 175 Attachment 3.............................................................................................. 185 Attachment 4.............................................................................................. 186 Attachment 5.............................................................................................. 189 Attachment 6.............................................................................................. 190 Attachment 7.............................................................................................. 195 Attachment 8.............................................................................................. 197 Attachment 9.............................................................................................. 198 Attachment 10............................................................................................ 207 Attachment11............................................................................................. 220 Attachment 12............................................................................................ 226 Attachment 13............................................................................................ 230 Attachment 14............................................................................................ 233 Attachment 15............................................................................................ 239 Attachment 16............................................................................................ 263 Attachment 17............................................................................................ 264

4

Introduction

LIST OF ACRONYMS

doll. USA ESCB ECB FRS I JSC KASE MCP NBK USA WFE

– – – – – – – – – – –

USA dollars European System of Central Banks European Central Bank Federal Reserve System Inflation Joint stock companies Kazakhstan Stock Exchange Monetary and credit policy National Bank of Kazakhstan United States of America World Federation of Exchanges

5

Monetary and Credit Policy

INTRODUCTION

Monetary and credit policy is one of the key directions in the realization of an effective state strategy. Instruments of the monetary and credit policy become main factors that influence on the economic units and provide conditions for their investment and economic activity. National Bank of Kazakhstan operates as an authorised body, responsible for the implementation of the advanced experience for the needs of the local market. The tutorial «Monetary and credit policy» designed according to core corricullum in Finance and syllabuse of the discipline «Monetary and Credit Policy» in order to provide working materials and tasks for establishement of theoretical and methodological skills as well as main competences in the sphere of monetary and credit regulation. The discipline «Monetary and Credit policy» is a practically oriented study course, main purpose of which is to provide core measures and usage of the instruments for economic growth of every state. The main spheres of monetary and credit policy are following: – Activity of central banks – Requirements and rules of money and credit circulation – Forms of financial and nonfinancial instruments using for regulatory purposes – Forming and investing of gold and currency reserves – Special conditions for economic units’ activity on the money and credit market – Development and fulfilment of the legislative requirements. Relevance of this book is determined by the importance of the money market for the distribution of investment resourses needed for the institutional development of every state. 6

Introduction

Practical material, presented in the book, reflects reforming stages of local monetary system’s infrastructure from the moment of its establishment till nowadays. Besides, there is an analisys of interconnection between monetary system and banking, pension, securities and other financial markets. For the purposes of practical skills’ development when studying students have opportunity to search particularities of the Kazakhstani monetary policy. As a case study, special tasks are designed for analisys of open market operations and establishement of gold and currency reserves investment portfolio management. Moreover, the tutorial includes special requirements for running of foreign central banks’ activity as a part of an overall concept of the monetary policy. The book contains the introduction, three main bodies, tests, practical and theretical tasks, cases, a glossary and a conclusion.

7

Monetary and Credit Policy

I. BASICS OF MONETARY AND CREDIT RELATIONS

1.1. Theoretical Basics and Historical Development of Monetary and Credit Relations 1.1.1. Essence of a Monetary and Credit Policy Monetary and credit policy is a complex of measures aimed to organize and support a money and credit market as well as a money circulation in economy. Basing on this definition the discipline «Monetary and Credit Policy» has following object, purpose and tasks. The purpose of the discipline is to study the particularities of monetary policy. Course’ tasks are: – Study of the theory and methodology of the monetary and credit policy – Research of the normative and legislative framework that determines conditions and requirements for running monetary and credit regulation – Study and analysis of the instruments of the monetary and credit policy – Study of foreign central banks and NBK’ activity – Analisys of the monetary and credit policy in Kazakhstan and abroad. The object of the discipline «Monetary and Credit Policy» is monetary policy’s content and instruments used for regulation of the money and credit circulation. There are four main terms, study of which is very important for receiving the basic knowledge. They are: «monetary policy», 8

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

«money and credit market», «central bank», «monetary and credit instruments». According to NBK, monetary and credit policy is a part of state economic policy, running by the central bank to affect on the monies’ quantity and cost in circulation. NBK runs monetary and credit policy to provide price stability [29]. According to the informational and analictical source Erewise.com, monetary policy is realized by a central bank for money supply regulation. The main tasks are to reach specific purposes such as decrease of inflation, an exchange rate support, improvement of employment and economic growth [30]. US Federal Reserve presents following definition: monetary policy is a part of the central bank activity to provide availability and cost of money and credit for achievement of national economic purposes [31]. According to the Bank of England, tha main purpose of the monetary policy is a price stability providing a low level of inflation, therefore, supporting economic purposes of the Government including economic growth and employment [33]. The same definition offers EU Cental Bank [35]. Thus, the term «monetary policy» is a monetary mechanism, developed to establish macroeconomic results and stable monetary system, which respects the level of economic development. Considering purposes and tasks of the monetary and credit policy, the main one is price stability, using measures to regulate inflation. This is true for Kazakhstan. By managing of money supply and market participants’ activity central banks provide sustainability of the money market and the financial system. The tasks of the monetary policy are following: – To create conditions for money and credit circulation – To provide development of money and credit markets and market participants – To provide effective functioning of the monetary and credit system – To determine money issue rules and norms for circulation 9

Monetary and Credit Policy

– To establish rules for credit organizations’ activity – To provide functioning of payment system and payment organizations – To realize measures for money supply and demand regulation. Term «money and credit market» concerns relations between market participants. Monetary policy has direct affect on the money and credit market and the monetary and credit system. The concept of «money market» determines the relationship between their participants. In turn, the monetary and credit system consists of a set of financial organizations that provide the issuance, circulation and storage of financial resources in the national economy. Monetary and credit policy provides realization of the following conceptual functions in economy: − regulative − controlling − restrictive − stimulative − distribution − investment. The central banks’ key directions is to regulate the exchange rate of the national currency and the level of inflation. In addition, the monetary authorities use various instruments to ensure financial stability and stability of the monetary system. Control function provides the usage of a set of measures that allow central banks and other financial authorized bodies to monitor the participants’ activity. The usage of financial instruments allows to stimulate or restict the economic activity of business entities. Distributive and investment functions specify that the money market is a part of the financial market of the country. It participates in the redistribution of financial resources between economic entities. The state regulation includes the development of normative and legal acts that establish conditions and procedures for conducting deals and transactions. 10

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

The objects of the monetary and credit system are money – in cash and non-cash forms, credit resources, interest rates, as well as other cash equivalents and liquid assets. The money and credit market has several segments – submarkets, that are divided according to the object of monetary and credit relations. The list of submarkets is presented in the Figure 1.

Figure 1. Money and credit market compose sceme Note: composed on the basis of presented materials

The money and credit market includes: – a market of the national currency circulation in cash – a market for non-cash payments and settlements where electronic money mostly used – a foreign exchange market estableished for foreign currency instruments. It is divided into exchange and over-the-counter markets – a repo-operations market, intended for short-term funding – a currency derivatives market is based on various foreign exchange assets – a credit market – a deposit market – markets for interbank deposits and loans. 11

Monetary and Credit Policy

Thus, monetary and credit policy is a set of instruments aimed to maintain money circulation and to create an effictive money and credit market. Based on the importance and meaning of monetary policy to ensure sustainable economic development, the discipline «Monetary Policy» is aimed to form knowledge and skills related to central banks activity aiming to provide monetary and credit circulation. Questions for self-control 1. 2. 3. 4. 5.

What are main functions and tasks of the monetary and credit policy? What is the meaning of the monetary and credit system? What are the tasks and functions of the money and credit market? What is the meaning and definition of monetary and credit policy? What is the purpose and objectives of the discipline «Monetary and Credit Policy»? 6. Which sector (markets) are included into the structure of the money and credit market according to types of financial instruments? 7. What are the basic concepts used in monetary and credit regulation? Working materials Task 1. Provide description of submarkets presented in the table below. № п/п

Market

1.

Cash market

2.

Description

Market of non-cash payments and settlements

3. 4.

Credit market Interbank credit market

5. 6.

Interbank deposit market Deposit market

7. 8.

Foreign exchange market Repo operations market

9.

Currency derivatives market 12

Used instruments

1.1. Theoretical Basics and Historical Development of Monetary and Credit… Task 2. Determine main functions of Monetary and credit policy. № п/п

Market

1.

Regulative

2.

Controlling

3.

Restrictive

4.

Stimulative

5.

Distribution

6.

Investment

7.

Regulative

8.

Controlling

9.

Restrictive

Description

Samples

1.1.2. Historic Developmet of the Money Theory The historical background for the development of monetary and credit relations are based on the evolution of money and credit. 1. Money. The history of money existance is associated with natural housholding, which subsequently developed into commodity production. In return, this process led to the development of industrial production. Money as an object of commodity and economic relations have passed the evolution: – from natural form to metal – from metal form to paper – from paper form to electronic forms. 13

Monetary and Credit Policy

First paper money – China

Figure 2. Forms of money from ancient times till IX century Note: designed based on [25] 14

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

The barter form of money expired itself with the development of the division of labor and production. The inconvenience of this payment form was connected with an inability to determine the corresponding equivalent exchange. The divisibility, rarity and non-wearing of metals have made it possible to use them as unified money. The value of precious metals – gold and silver, has become a key factor in their widespread use for these purposes on different continents. Coins, ingots and other forms of metal processing have become means of payment and accumulation of wealth. Paper money subsequently squeezed out the metal content of money and became widespread in the world. Scientific and technological development has led to the emergence of electronic form of money, existing in the form of electronic records in specialized information systems. In economic science, there is an opinion that money, first of all, is artificially created product being exchange equivalent for the needs of mankind. The evolution of economy from ancient times to the present day has determined the existence of various theories and views on money and credit (mostly in a form of usury). Shortcuts of some theories and views on money are presented in Table 1. Table 1 Evolution of economic thoughts on money

Civilization/school Resource /thinker 1 I. Ancient East Source «The Epic of Ipuser» (Ancient Egipt) Hamurappi Code (Vavilone)

Shortcuts on money and credit (usury) 2 Preventing the uncontrolled growth of loan operations and debt slavery For untimely payment of debts do not deprive of land plots The term of debt is not more than three years The limit of a monetary loan can not exceed 20%, in real subject – 33% of its original amount 15

Monetary and Credit Policy

1 Treatises «Guan Tzu» (IVIII centuries BC, Ancient China)

Xenophon (431-354 BC, Ancient Greece)

Aristotle (384-332 BC, Ancient Greece)

2 Gold as a measure of the calculation of state resources. State regulation of bread prices Components of wealth – gold, pearls and other material goods, that have commodity essence Money was invented by people so with their help commodity circulation and accumulation of wealth could be effected, but not for enrichment Functions of money in display the measure of value and means of circulation are related to the sphere of the economy, and the use of money as usurious capital – to the sphere of chrematistics

II. Middle Ages Ibn-Khaldun (1132-1406, North Africa) F. Aquinas (1225-1274, Italy)

III. Mercantilism Nominalistic theory of money (XV-early XVI centuries., Early mercantilism)

The quantitative theory of money (2nd half of the 16th-17th centuries, Late mercantilism)

The role of money must be fulfilled by fullfledged coins from the two metals created by God – gold and silver The reason for the emergence of money was the expression of the peoples’ will to possess the surest measure in trade and turnover Only money (gold, silver) and treasures personify the wealth of a nation and a state A fixed ratio is established for the circulation of gold and silver coins (the system of bimetalism) The government, as a rule, is engaged in spoiling the national coins, reducing their value and weight The value of money is inversely proportional to their number; the price level is directly proportional to the amount of money; the growth in the supply of money increase demand on them, facilitates trade

16

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

1 IV. Classical school

2 Money – spontaneously released in the commodity world of goods; money is a technical tool, a thing that exaggerates the process of exchange

A. Turgot (1727-1821, France)

Gold and silver vary in price not only in comparison with all other goods, but also in relation to each other, depending on their greater or lesser abundance

A. Smith (1723-1790, Scotland) J.S. Mill (1806-1873, England)

Money is a great wheel of circulation

V. Economic Romanticism P. Proudhon (1809-1865, France)

The value of the money itself "varies inversely with the amount of money: any increase in quantity lowers their value, and any decrease increases it in exactly the same proportion

Liquidation of money and introduction instead of them of circulation bans; destruction of interest through the organization of a free (interest-free) loan

Marginalism

Recognition of the main functions of money – means of circulation, measures of value or units of account, savings, savings or means of preservation of value

K. Menger (1840-1921, Austria)

Exchange is not only a benefit, but an economic sacrifice caused by an exchange transaction that takes away "a part of the economic benefits that can be extracted from the existing exchange relationship

VI. Neoclassicism I. Fisher (1867-1947, America) A. Pigou (1877-1959, England)

The exchange equation MV=PQ To the extent that the liquidity of money will take place, there will be an adequate price adjustment 17

Monetary and Credit Policy

1 VII. Keynesianism J.M. Keynes (1883-1946, Great Britain)

VIII. Neo-Keynesianism (50's of the XX century)

IX. Monetarism M. Friedman (1912-2006, USA)

2 The system of market relations is by no means perfect and self-regulating, the maximum possible employment and economic growth can provide only active state intervention in the economy The state will have to exert its guiding influence on the propensity to consume in part by the appropriate system of taxes, partly by fixing the rate of interest and, possibly, in other ways The concept of the dependence of character and dynamics on economic processes on the proportions between investments and savings, namely: the outstripping growth of the former – the reason for the increase in price growth, and the second – the reason for under-loading of enterprises, part-time employment The re-emergence of the priority value of money, money supply and money circulation in economic processes Inflation is not always and everywhere is a phenomenon of money [22, с. 568]

Composed based on [19]

The development of schools and trends in economic theory formed modern views on the Money Theory. Most of the postulates of the great economists of the 20th century were included into the practice of central banks. One of the central items are the Theory of Demand and Supply and The Quantitative money theory. 1. Supply and demand. Macroeconomic equilibrium is achieved by a balance of supply and demand for money. 18

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

Firms and households have a demand on credit resources – short-term, medium-term and long-term. At the same time, demand is the amount of assets that organizations and households want to attract on the market at a rate certain level. The money supply is formed on the modern market at the expense of investors – savings of firms and households, as well as financial organizations. Financial organizations latter accumulate their resources and attract assets. The supply is the amount of resourses that investors are willing to provide for the interest rate that corresponds to their expectations. The supply of money is formed as financial resourses in national and foreign currencies. Demand and supply curves are shown in Figure 3.

Figure 3. Theory of supply and demand on the market Note: designed on the basis of [19, 21, 22]

This chart is applicable for the credit market. The market is in an equilibrium, when the volumes of supply and demand are equal. Curves intersect at the «same» price, providing an equilibrium interest rate. 19

Monetary and Credit Policy

A simple function of the demand for money determines the direct dependence of the cash resourses from the level of income and the inverse dependence from the level of interest rate [22]. 2. Theory of Tranzaction Demand. According to economic theory, modern theories of demand for money analyze the preferences of individual economic agents in relation to maintaining a certain level of real money reserves. J. Keynes put forward a Liquidity Preference Theory, according to which there are three motivations for saving money in cash: transaction, speculative and precautionary. People keep money for running operation (transactions) – so with the incomes growth, the number of transactions is growing. The theory of transaction demand is related to the Quantitative Money Theory [22, p. 456]. In turn, the speculative demand for money depends on the interest rate. At the same time, the precautionary motive assumes that in conditions of uncertainty, an individual may be forced to make sudden payments, so he keeps a certain amount of money in his hands to avoid a shortage in cash [22, p. 456-457]. 3. Quantitative Money Theory Economic science contains important postulates of the Money theory. One of them is the quantitative money theory, represented by the following formula [19, p. 454; 22, p. 368]: M x V=P x Y

(1)

where М – quantity of money; V – money circulation velocity (according to income); Р – price level; Y – real income or a level of production. This model allows you to evaluate one of the components at specified values of other indicators. In some sources, the output level (Y) denotes (Q) – the volume of production of goods, works and services. Based on the theory, an equation was derived, known as the Cambridge equation: M =kPY 20

(2)

1.1. Theoretical Basics and Historical Development of Monetary and Credit…

where k=1/V – coefficient of proportionality between the nominal income and the desired monetary stocks, that is, the part of the income that economic agents desire to keep in cash, or the monetization factor [22, c. 454]. 4. Neoclassical model. According to the neoclassical model, aggregate demand for money is a function of nominal income (PY), and the supply of money is exogenously established. The theory is presented in Chart 4 below.

Figure 4. Neoclassical model of equilibrium on the money market Note: composed on basis of [22]

The neoclassical model of the money market takes into account the transaction demand for money [22, c. 456]. 5. «IS-LM» model. On the basis of the Keynesian theory, «IS-LM» model was developed. It reflects the general equilibrium on the real and money market with the help of curves, where IS – investment-savings; LM – money liquidity. 21

Monetary and Credit Policy

IS curve demonstrates different variaties of the combination between the interest rate and income in the equilibrium for savings and investments. LM curve characterizes the equilibrium in the monetary sector of economy and reflects the combination of the interest rate and the level of real income under which the money market is runs in balance – Figure 5.

Figure 5. Equilibrium in «IS-LM» model Resource: [22, p. 548]

The change in the money supply volume or the interest rate leads to a shift in the LM curve, leading to a new equilibrium. The «IS-LM» model has an impact on aggregate demand, leading to a change in output. Based on the priorities of modern development, each state determines the degree of intervention into economy, including instruments of monetary and credit regulation and control. The development of monetary policy is based on leading theories and practices in this area, taking into account the situation of the domestic monetary and credit system. 22

1.1. Theoretical Basics and Historical Development of Monetary and Credit… Questions for self-control 1. What is the nature of the money evolution, including natural and monetary forms (consider the evolution and rationalist approach to emergence of money)? 2. What factors influenced on the emergence of money? 3. What are the opinions of economists on the object, subject and meaning of monetary relations, for example, J. Stewart, A. Smith, Paul Samuelson, John K. Galbraith and others? 4. What are the main features of the Money theory? 5. What are the distinguishing features of the metal and nominalistic money theories? 6. What are the main postulates on the issues of monetary relations in the Monetarism and Keynesianism theories? 7. What is the meaning of the classical and neoclassical theories on monetary and credit relations? Working materials Task 1. Provide description of main Monetary theories. School

Shortcuts on money and credit (usury)

I. Mercantilism II. Classical school III. Economic Romanticism IV. Marginalism V. Neoclassicism VI. Keynesianism VII. Neo-Keynesianism (50's of the XX century) VIII. Monetarism

23

Representatives

Monetary and Credit Policy Task 2. Determine main thoughts of famous economists. Resource /thinker

School

Shortcuts on money and credit (usury)

Nominalistic theory of money (XV-early XVI centuries., Early mercantilism) The quantitative theory of money (2nd half of the 16th-17th centuries, Late mercantilism) A. Turgot (1727-1821, France) A. Smith (1723-1790, Scotland) J.S. Mill (1806-1873, England) P. Proudhon (1809-1865, France) K. Menger (1840-1921, Austria) I. Fisher (1867-1947, America)A. Pigou (1877-1959, England) J.M. Keynes (1883-1946, Great Britain) M. Friedman (1912-2006, USA) K. Marks (1818-1883, Германия)

1.2. Basics of the Monetary and Credit Regulation The money and credit market is one of the sectors of the financial system and the economy of the country. It is highly liquid 24

1.2. Basics of the Monetary and Credit regulation

and sensitive to different impacts, therefore this market is the most vulnerable to various risks. In addition, some individuals may intend to conduct unjustified actions with financial instruments for obtaining superprofits. In order to prevent risks and threats, to increase the stability of this sector, as well as to exclude malicious acts with financial instruments that lead to the violation of the interests of market participants, there is a strong necessity to regulate the activities of the market participants. Main purposes of the state regulation of the money and credit market are following: – ensuring the stability and sustainability of the monetary and financial system – assistance to the development of the money and credit market – minimization of risks – creation of favorable conditions for the effective and legal functioning of the market and its participants – creation of favorable conditions for the implementation of monetary relations – development of money circulation. Tasks of state regulation are following: – establishment of rules for the functioning and performance of activities of participants in the money market – establishment of the monetary policy – implementation of the policy on the development of the monetary and credit system – protect the rights and interests of market participants – infrastructural development of the monetary system. Main state functions of the monetary and credit regulation are: – creation of normative and legal framework – regulation and control of market participants and their activities – regulation of systemic risks – maintenance of the payment system functioning – conducting monetary operations and making transactions with financial instruments on the market. 25

Monetary and Credit Policy

The state politicy, aimed to establish monetary regulation, pursues the goal of creating a stable, efficient and competitive money market. Such policy is directed on: – development of infrastructural organizations – formation of the payment system – expansion of the list of financial instruments and operations; – increasing the attractiveness of the market – protecting the market participants’ rights in running monetary and credit relations – introduction of international stadards – increasing the integration of the local market into the global system. Interaction between state regulation and market participants is presented in the Figure 6.

Figure 6. Monetry and credit market structure Note: composed by athor on the basis of offered material 26

1.2. Basics of the Monetary and Credit regulation

State regulation should take into account the priorities of the financial market, monetary and credit system, investment policy, macroeconomic development and other directions. The degree of the money market involvement into the financial sector, investment and economic processes determines the core basics of the monetary relations development. Central banks and other financial authorities play a key role in the implementation of current tasks to create the efficient money market. These organizations carry out the regulation and control of both the market itself and its members. The state regulation of the domestic money market is carried out by the NBK. It is the authorized body that regulates the financial market and financial organizations. Legal regulation of the money market relations is provided by the following normative and legal acts: – Civil Code of the Republic of Kazakhstan – Tax Code of the Republic of Kazakhstan – Law of the Republic of Kazakhstan «On Payments and payment system» – Law of the Republic of Kazakhstan «On state regulation, control and supervision of the financial market and financial organizations» – Law of the Republic of Kazakhstan «On National Bank of Kazkahstan» and others. NBK plays the leading role in the regulation and development of the money and credit market, being the authorised body and active market participant. Questions for self-control 1. What are the features of monetary regulation? 2. What functions and tasks does the authorized body of the money market perform? 3. What are the purposes and objectives of state regulation, control and supervision of the financial market and financial institutions? 4. What are the key normative and legal acts issued for the purposes of monetary regulation? 5. What are the goals and objectives of the central bank? 27

Monetary and Credit Policy 6. What measures do NBK or other central bank apply for the purposes of monetary regulation? 7. What kind of money market participants do you know? Working materials Task 1. Provide description of money market participants, presented in the Figure 6. Task 2. Specify financial instruments and transactions. №

Instruments / transactions

1.

Deposit

2.

Interbank deposit

3.

Credit

4.

Interbankcredit

5.

Repo

6.

Swaps

7.

Payments

Description

Samples in Kazakhstan

Market volume

1.3. Subjects of Money and Credit Market The money market participants are subjects, involved into monetary relations by conducting transactions and deals with financial instruments. The indicated subjects, interact with each other, in the course of realization of monetary relations. These subjects run following activity: 1. The Central Bank. The central bank is a «Bank of Banks». It performs the issuing function, ensuring the issuance, placement and circulation of the 28

1.3. Subjects of Money and Credit Market

national currency in the form of banknotes and coins. The central bank retains the exclusive right to issue monetary units of the country.

Figure 7. Subjects of the monetary and credit system Note: composed on the basis of offered materials

The central bank of the country carries out monetary regulation and implements monetary policy in order to ensure price stability, promote economic growth and employment. As part of its functions, the «Bank of Banks» organizes a system of payments and settlements, as well as transfer operations. Second tier banks’ correspondent accounts are opened at central bank. In addition to these areas of activity, the central bank, as an authorized body, can exercise supervisory functions regarding to financial organizations. In detail – see section II. 29

Monetary and Credit Policy

2. Financial organizations. Financial organizations are active participants of the money market. They are: – banks – insurance companies – pension funds – investment funds – professional participants of the securities market – credit partnerships – pawnshops – exchange offices – microfinancial organizations. These organizations participate in money circulation, as parties to deals or intermediaries in conducting transactions. In addition to these areas of activity, the central bank, as an authorized body, can exercise supervisory functions for financial organizations. In detail – see section II. The most important participants in the monetary system are commercial banks. Every bank receives a license for conducting banking operations. The standard banking operations include: – opening of accounts – making payments – acceptance of deposits – issuance of loans and credits – cash services for customers – storage of different values – conducting transactions with foreign currency. Second-tier banks work with foreign and national currencies in non-cash and cash forms. In addition, banking organizations are entitled to obtain a license for brokerage and dealer activities and a license for custodial activities. Basing on licenses, banks as brokers and dealers invest their own and attracted assets through the stock exchange trading, form a portfolio of financial instruments. Banks on the stock exchange market conduct different operations in several sectors, including the foreign exchange market, 30

1.3. Subjects of Money and Credit Market

government securities market, repo operations market, corporate securities market, derivatives market. Obtaining the license for custodian activity means that the bank is a custody, that offers accounting and storage service of financial instruments and money. In addition, the custodian can keep documentary financial instruments. Custody can also serve as a representative of the creditor (for bonds issues) and depositary agent (for securities payments). The issuer of securities uses the banking services. In this case banks being as paying agents pay out dividends on shares; the principal and interest rate on bonds to investors. 3. Stock exchange An exchange refers to financial organizations, but the special conditions of its activity makes it possible to separate this entity into a separate category. The trading floor of the exchange provides circulation and trade of various financial instruments. The Stock Exchange performs the following functions: – an organizer of auctions – a central counterparty, which acts as a party to the transactions conducted on the exchange, for each seller and each purchaser of financial instruments, for example, on the derivatives market. The stock exchange prganises tradings with financial instruments in its IT system, and if needed sells and buys to exclude defaults, thus performs as the central counterparty – a clearing house. The clearing activity includes the process of determining, verifying and forwarding information about the requirements and obligations of participants in a transaction with financial instruments. Clearing is an important stage that is necessary for completing settlement of transactions [2]. 4. Infrastructural organizations. Infrastructure organizations can be created by the central bank or together with market participants. Such organizations ensure the implementation of important tasks for the purposes of the functioning of the monetary system. The key organizations are 31

Monetary and Credit Policy

interbank settlement centers, guarantee funds, reserve funds, clearing houses, registrars, depositories, self-regulating organizations, associations, telecommunication centers, credit bureaus and others. Depending on the purpose of creation infrastructure organizations can be commercial, state or mixed ownership. To ensure the public interest the central bank or other financial authorities initiate forming of the infrastructure organizations, drived by advanced experience, or main needs of the financial market. 5. Economic entities. The main consumers of financial services are legal entities and individuals that participate in monetary relations through various operations and use financial instruments in their activity. The money market is part of the country's financial market. Questions for control 1. 2. 3. 4. 5. 6. 7.

What functions and tasks does the bank of banks fulfil? What specific activities do the stock exchange, the central depositorium? What services does a central bank offers to financial organizations? What are the functions and tasks of infrastructure organizations? What are main services of banking organizations? What is the essence of debt operations? What are features of the payment systems?

Working materials Task 1. Provide description of credit system components, presented in the Figure 7. Task 2. Specify credit system componets on Kazkahstan . №

Title

1 1.

NBK

2.

Banks

3.

Credit bereaus

Description 2

3

32

Samples in Kazakhstan 4

Tasks and purposes 5

1.4. Main indicators of the money market 1 4.

2 Interbanking payment and settlement centre

5.

Development institutions

6.

Ministry of Finance

7.

Stock exchange

8.

Companies

3

4

5

1.4. Main Indicators of the Money Market The main targets of monetary policy are money market indicators, one of the most important – aggregates, the level of inflation and the exchange rate. There is a close relationship between these indicators and economy. National currency is issued by the central bank of the country and exists in the form of cash – banknotes and coins; or in non-cash form – like entries on accounts of counterparties – second tier banks. Both forms constitute a monetary base, which additionally includes foreign assets expressed in different currencies [20; 22, c. 15-21]. In many sources, the monetary base is also defined as the amount of cash and reserves of commercial banks. For the purposes of monetary policy, central banks use indicators such as monetary aggregates, inflation rate, and the exchange rate. 1. Monetary aggregates. The amount of money in the bank correspondent accounts and the cash in circulation summarizing the total money amount in economy – money supply. The money supply is subdivided into the following monetary aggregates, presented in Figure 8. 33

Monetary and Credit Policy

Figure 8. Structure of money and credit market Source: composed basing on [20, p. 20]

Aggregates decrease in terms of liquidity – C and M1 have absolute liquidity. In some sources, cash (C) is named M0 aggregate. 2. Inflation Money has a purchasing power that constantly changes under the influence of various factors. Reducing the purchasing power of a monetary unit leads to inflation – a money depreciation. Types of inflation (I) are presented in Figure 9. The reverse process is defined by the terms «disinflation» leading to a slowdown of inflation or zero-level inflation. Another process is «deflation» when price level belows zero (negative values of the price level relative to previous periods). In a market economy, price increases and fluctuate forming visible inflation. In the case of fixing prices or their directive setting – centralizely planned economy, inflation takes a hidden or depressed form, which is expressed in the goods and services scarcity/deficite on the market [22, p. 554]. In general, inflation always accompanies economic growth and low rates of inflation indicate that there is an insignificant share of 34

1.4. Main indicators of the money market

free money. However, inflation has social and economic consequences. It is critically when its rates become unmanageable. The consequences include price distortion, disbalance in income distribution, decrease of production, decrease in the purchasing power of individuals, and others [22, p. 572].

Figure 9. Types of inflation Source: composed basing on [22, p. 556]

With the growth of inflation, the monetary authorities apply more stringent measures to limit the money supply in economy. The emergence of stagflation is critical leading to a decline in pruduction, accompanied by rising unemployment and inflation [22, p. 573]. In economic science there is the concept of «inflation tax», which refers to the issuing activity of the state. With an additional issue of the national currency, amount of money in economy 35

Monetary and Credit Policy

depreciates its purchasing power, followed by overall decrease, so leading to losses of economic entities [22, p. 573]. At the same time, the economist O. Phillips identified the relationship between inflation and unemployment. This theory is called «Phillips Curve». O. Phillips conducted research, according to which he calculated the inverse relationship between the unemployment rate and the nominal wage rate. Reduction in the inflation rate is accompanied by an increase in unemployment in the short term, and vice versa, when the level of prices increases, unemployment decreases – inflationary growth in prices and wages stimulates the introduction of labor and expansion of production [22, p. 575-576]. 3. Exchange rate The national currency exchange rate is the price of a country's currency expressed in monetary units of another country. Exchange rate: – used in cross-border operations and conversion; – affects the value of imported and exported goods; – determines the price of capital when it is imported and exported for the purpose of making investments; – used to assess macroeconomic indicators and comparability of prices of domestic and foreign goods and services. The importance of the exchange rate makes it as one of the main objects of regulation and influence issued by the central bank in conducting of monetary policy. The exchange rate influenced by the demand and supply of national and foreign currencies plays important role in running internal and external transactions. The depreciation of the national currency indicates its depreciation against foreign currency. The formation of an equilibrium exchange rate, corresponding to the needs of the national economy, is one of the main priorities of monetary regulation. Reduction of the national currency (depreciation/devaluation) – a week exchange rate has a positive effect on the country's export operations, but leads to a rise in the cost of imported goods, works and services, as well as foreign capital. 36

1.4. Main indicators of the money market

The appreciation of the national currency – a strong exchange rate raises the cost of domestic goods when they are exported abroad. Domestic producers suffer from price competition from foreign suppliers. Thus, for the purposes of implementing monetary policy, the central bank regulates the money supply, monetary aggregates and the price of money-the interest rate. Questions for self-control 1. What are the main functions of money as the measure of value, the medium of circulation, the means of accumulation, the means of payment and the function of world money? 2. What are the features of modern money? 3. What are the basic forms and methods of non-cash payments? 4. How concepts and essence of money supply, monetary base, monetary aggregates are determined? 5. What are the features of monetary circulation? 6. What are the characteristics of the impact of monetary circulation on GDP? 7. What are the types of inflation? Working materials Task 1. Specify types of inflation. №

Type

1.

Deflation

2.

Disinflation

3.

Moderate inflation

4.

Galloping inflation

5.

Hyperinflation

6.

Stagflation

Description

37

Samples in some countries / period / reasons

Measures of estimation

Monetary and Credit Policy Task 2. Specify Money aggregates. №

Title

1.

M0

2.

M1

3.

M2

4.

M3

Description

Samples in Kazakhstan

38

Tasks and purposes

Volumes

2.1.Central Banks Activity

II. MONETARY AND CREDIT POLICY MECHANISM

2.1. Central Banks Activity The key point of the monetary and credit system is a central bank of the country. The central bank is the upper or the first tier of the country's banking system. According to economic goals and objectives, the central bank's objective can be price stability, employment promotion and economic growth of the country. Being the upper level of the banking system, the central bank determines the rules of monetary circulation, the activities of credit institutions, the functioning of payment systems. It performs other tasks necessary for the effective functioning of the national monetary system. The central bank developes a set of measures, determines the directions and priorities for the development of monetary relations. The central bank establishes national currency. It is an issuing center that is responsible for money production, placement and circulation. To ensure the stability on the domestic money market, the firsttier bank implements monetary policy and uses various instruments, which include: – discount rate (refinancing rate); – specifications of reserve requirements; – open market operations [22, 28]. The central bank develops a legal framework that allows setting rules for the functioning of the system and its participants, as well as determining the procedure for using monetary policy instruments. Information on the activities of the central bank is shown in Figure 10. 39

ІI. Monetary and Credit Policy mechanism

Figure 10. Central bank’s activity Note: composed basing on presented material

Figure 11. Activity of the central bank on the financial market Note: composed basing on presented material 40

2.1.Central Banks Activity

The central bank can act as a regulator and financial authorities of the country. It provides participants’ regulating, controlling, supervising and licensing on financial market. As part of its activities, the central bank establishes prudential standards. Information on the activities of the central bank presented in Figure 11. The Bank organizes functioning of the national payment and settlement systems, ensures state integration into the global payment network. The central bank manages and stores gold and currency reserves of the state. These capital should cover a certain level of national debt, and can be used for the implementation of monetary policy. The Bank of Banks monitors the main macroeconomic indicators and maintains the financial and financial indicators. The additional activity includes currency regulation and control of economic entities. The Bank establishes legislation, normative and legal acts, its own internal rules (internal documents), and guidelines for use of international standards and recommendations [28]. The central bank may be endowed with other functions and competences. Activity of individual central banks of foreign countries presented below and in attachements. 1. The US Federal Reserve System. History the US Federal Reserve System of the (FRS) began since 1913 when the law «On federal reserve» had been passed. The FRS precursors were successively several private banks that failed to create an effective centralized financial system of the country. The creation of the FRS was the result of counteraction to a number of interbank crises in 1873, in 1893 and in 1907, because of which the need for a single regulatory and issuing body became evident. To date, the FRS takes on the following functions: − fulfillment of the tasks of the Central Bank of the country; − compliance with the balance between public interest in the United States and the interests of commercial banks; 41

ІI. Monetary and Credit Policy mechanism

− supervision and regulation of the country's banking system, protection of the interests of investors and clients of credit institutions; − issuance of money – US dollars; − regulation and stabilization of financial markets, control over risks; − providing depositary services for the US government and official international institutions; − participation in the functioning of the system of international and domestic payments; − elimination of liquidity problems at the local level and provision of loans to credit institutions; − strengthening the role of the United States in the global economy. FRS includes the following main structural units: a board of governors consisting of seven people appointed by the president of the United States and approved by the Congress for a period of 14 years; Federal Open Market Committee, Federal Advisory Council, 12 Federal Reserve Banks, which are regional representatives of the Federal Reserve, and other credit institutions that are members of the system. The particuliarity of the FRS (unlike the traditional central banks of other countries, for example, the Bank of England or the Central Bank of Russia) is that it is built not on state but private capital. Any credit institution that meets the requirements of the Federal Reserve can acquire its shares. This allows you to receive a fixed dividend income, and also gives the right to vote when electing six of nine regional administrations. Control over the activities of the Federal Reserve is exercised by the House of Representatives of the US Congress, which annually reports, and the Banking Committee of the Congress that reports semi-annually. FRS annually audits. In addition, from the point of view of the law, the US President can dismiss any FRS Governor, but this norm has never been applied to the present day. One of the most important functions of the FRS is money issue. In practice, it is made as follows. Released money goes mainly to 42

2.1.Central Banks Activity

purchase US government debt operations – treasury obligations. Only then banknotes come into circulation. Detailed information on FRS – please see in attachement. 2. The European Central Bank system. The European Central Bank (ECB) is a financial institution of the European Union regulating the monetary policy of the eurozone member countries. The headquarters is located in Frankfurt am Main, Germany. Officially, the ECB was established in 1998 on the basis of the 1997 Amsterdam Agreement. However, the process of its creation began long ago. After the Second World War, the unification of Europe began providing the formation of a single market space. In 1947-1957 there was region integration, the European payment union appeared. In 1957 the largest countries of Europe united in the European Economic Community (EEC). In 1979, a monetary ECU was introduced for mutual settlements, the rate of which was tied to a basket of European currencies. In 1988, a memorandum on the creation of the European currency space and the European Central Bank was signed. In 1992, Maastricht concluded an international treaty on the creation of the European Union. In January 1994, in accordance with this agreement, the European Monetary Institute was established in Frankfurt am Main, whose tasks included preparing for the transition to a single euro currency. And in 1998 it was transformed into the European Central Bank. To date, the ECB is a special legal entity operating under international agreements. Its authorized capital at creation was more than 5 billion euros, shareholders are the central banks of the countries of Europe. The largest contributions were made by Deutsche Bundesbank – 18.9%, the Bank of France – 14.2%, the Bank of Italy – 12.5% and the Bank of Spain – 8.3%. The share of the other central banks of the Eurozone countries is 0.1-3.9%. The supreme body of the ECB is the Board of Governors, which includes members of the executive council and the heads of central banks of the euro zone member countries. The current management of 43

ІI. Monetary and Credit Policy mechanism

the bank is entrusted to the executive board, which consists of six members, including the chairman and his deputy. Their candidacies are proposed by the board of governors and must be approved by the European Parliament, as well as by the heads of state belonging to the euro area. The main functions of the European Central Bank are: – maintaining economic stability in the euro area, primarily inflation at no more than 2% – development and implementation of monetary policy in the euro area – management of gold and foreign currency reserves – Euro emission – setting of interest rates. To carry out these functions, the ECB in practice provides stabilization loans, holds mortgaging auctions for leading banks, participates in foreign exchange transactions, and also makes other transactions in open markets. In its activities, the European Central Bank is formally independent. At the same time, it must annually report to the European Parliament, the European Commission, the Council of the European Union and the Council of Europe [37]. Detailed information – please see in attachement. 3. Bank of England. The Bank of England is a public lending institution entrusted with the functions of the Central Bank of the United Kingdom of Great Britain and Northern Ireland. The full official name is the Governor and the Company of the Bank of England. The unofficial name is «The Old Lady». The Bank of England is one of the oldest in Europe and in the world. It was founded in 1694 as a private company to finance the war with France. The founders were 1,268 shareholders, who provided the first loan to the government in the amount of 1,200 pounds sterling. From a legal point of view, the loan was granted to the king at 8% per annum in the form of banknotes and bills. Since its inception, the bank has obtained the right to conduct transactions with precious metals – gold and silver, issue and record 44

2.1.Central Banks Activity

bills, provide loans for collateral. At the same time, the bank was forbidden to lend to the royal family without the sanction of the British Parliament. The ascent of a private credit institution to the level of the Central Bank of the country was not accidental. This was promoted by the special position of the Bank of England. So, already the next year after the creation, he received a monopoly right to issue money. In 1697 the parliament passed a law under which the forgery of banknotes issued by this financial institution was punishable by death. At the same time, the establishment of new large banks was prohibited. In 1708, the legal norms became even more severe. There was a ban on the issuance of bearer bills – this could only be done by the Bank of England. To avoid competition, it was forbidden to create companies whose number of founders would have been more than six people. Outside of the law was the activity to provide short-term loans (up to six months). Since 1844, the Bank of England, according to the accepted act of Robert Peel, has become a fairly open organization – he was weekly obliged to publish information about his balance. In addition, the bank was divided into two departments: the issuing and the banking. It was for the first time that the Bank of England used the system, which is the progenitor of the modern system of accounting for assets and liabilities of the Central Bank of most countries. In the issuing department, liabilities consist of bank notes in circulation and bank notes in the banking department. Assets are those reserves that ensure the issuance of money: government securities, gold and foreign currency reserves. The issued banknotes are transferred to the bank department. The liabilities of the banking department represent the authorized capital, which has not changed since 1844 and is £ 14.5 million, accounts of foreign securities, the International Monetary Fund, the International Bank for Reconstruction and Development, as well as government deposits and deposits of commercial banks. The assets of the banking department are state obligations, 45

ІI. Monetary and Credit Policy mechanism

discounted bills, loans granted. In addition, this section of the balance reflects the banknotes received from the issuing department, but not yet issued. In 1946, the Bank of England was nationalized. To this end, the shareholders of the credit organization transferred their shares to the UK Treasury, and in return received government debt securities. The last law regulating the Bank of England was adopted in 1998. According to this document, the management of the organization is entrusted to the board of directors, which includes the manager, two of his deputies and 16 members of the council. All of them are appointed by royal decree – but in fact the queen only approves the decision of the parliament, since the country is a constitutional monarchy. The term of office is defined for the manager and his deputies at five years, for the members of the council at three years. It is possible to extend the term of office. Meetings of the Board of Directors are held at least once a month. The Bank of England has the following functions: – control over the level of inflation, ensuring the purchasing power of the national currency and the stability of its exchange rate; – maintaining the reliability of the country's financial system; – ensuring the efficiency of the banking sector. Issues of conducting monetary policy are now transferred to the Committee on Monetary Policy, whose competence is to determine the official interest rates. However, this state body, consisting of prominent economists, is chairman of the Bank of England. The Bank of England has a monopoly right to issue banknotes in England and Wales. At the same time, the Bank of Scotland and the Bank of Ireland (Northern Ireland) can issue their own money by providing such a reserve with a reserve of bank notes of the Bank of England at a rate of 1:1 [37]. Detailed information – please see in attachement. Thus, the central bank is a body in the system of state structure, whose competence includes the development and implementation 46

2.1.Central Banks Activity

of monetary policy. In its activities, the bank of banks is guided by the interests of the state; is based on the world's leading practice and international standards. Detailed information on central banks activity in different countries presented in attachements 9-14 to this tutorial. Questions for self-control 1. What are the main objectives and objectives of the central banks in the field of monetary policy 2. What are the functions of the central bank? 3. What are the objectives, objectives and functions of the central banks and monetary authorities of the EU, US, UK, Malaysia, UAE and other countries? 4. How does the payment system function? 5. What are the functions of the central bank in relation to the formation of gold and foreign currency reserves? 6. What tools does the central bank use to conduct monetary policy? 7. What are the goals and objectives of the first-tier bank in relation to the banking sector? Working materials Task 1. Specify purposes and tasks of a central bank. №

Direction

1.

Inflation

2.

Money issue

3.

Financial authority

4.

Regulatory body

5.

Policy maker

6.

Portfolio manager

Purpose and Tasks

47

Description

Measures of estimation

ІI. Monetary and Credit Policy mechanism Task 2. Specify central banks activity in different countries. №

Country

1 1.

2 Kazakhstan

2.

Russia

3.

Ecuador

4.

Egypt

5.

Denmark

6.

Equatorial Guinea

7.

Finland

8.

France

9.

Saudi Arabia

10.

Ucrain

11.

USA

12.

Canada

13.

Gabon

14.

Gambia

15.

Georgia

16.

Germany

17.

Ghana

18.

Greece

Bank’s Name

Purpose and Tasks

Monetary instruments

Outcomes

4

5

6

3

48

2.2. Directions of the Monetary and Credit Policy 1 19.

2 Grenada

20.

Guatemala

21.

Guinea

22.

Guinea-Bissau

23.

Malaysia

24.

Kenya

25.

Luxembourg

26.

Korea, North

27.

Korea, South

28.

Kuwait

29.

Honduras

30.

Hong Kong

31.

Hungary

32.

Brasil

33.

Spain

34.

UAE

35.

Turkey

3

4

5

6

2.2. Directions of the Monetary and Credit Policy 2.2.1. Priorities of the Monetary and Credit Policy Instruments of monetary policy are used by central banks to carry out their main functions in the area of regulating monetary circulation, 49

ІI. Monetary and Credit Policy mechanism

forming a stable and competitive financial market of the country. In the context of globalization and integration, first-tier banks are adjusting the measures used, taking into account the trends in the partner countries and the world arena. Monetary policy directly affects the economic development of the country. In conditions of stress on the money, credit and currency markets, the set of measures taken to stabilize the situation must take into account the interests of economic entities that are exposed to the aggressive influence of the competitive environment. When signals appear that indicate an excess of money in circulation, central banks use various measures for their sterilization, which can have short-term, medium-term and long-term effects. In the absence of the possibility of effective regulation of instruments of direct impact, deeper reforms and reforms of the monetary system are required. Determination of priorities for monetary regulation and the use of appropriate instruments are the exclusive competence of central banks that perform functions and tasks in the field of ensuring price stability, regulating the money supply and money circulation, the formation and development of the payment system, in some cases, the financial system, and other directions. Against the backdrop of general positive trends in the world market, the toolbox selected by the central bank allows to stimulate and push the country's economy to further growth. In turn, given the deterioration of the economic situation inside and outside the state, such a set is aimed at protecting and preventing a negative impact on the economy of the country, both in the present and in the future. The Central Bank uses various directions and instruments of monetary policy depending on the set goals and objectives. The applied policy can be in the interval between the two absolute «poles» of monetary policy – the policy of «expensive» money and the policy of «cheap» money, the so-called restrictive and expansionist politicians, respectively. Figure 12 presents varieties of monetary policy. In the context of integration and globalization processes, the implementation of an effective monetary and credit policy is associated with risks that arise globally and regionally – on capital, 50

2.2. Directions of the Monetary and Credit Policy

goods, raw materials, labor markets. Such state policy must comply with the priorities of economic development, taking into account the existing situation on the domestic and foreign markets. As a result, world trends have a direct impact on the internal economic processes of a particular country under consideration.

Figure 12. Types of monetary policies Source: composed basing on [22, с. 461]

Figure 13 shows the model for adjusting the policy to match a certain stage of the domestic market's economic cycle. Depending on the needs of the economy, the direction of monetary policy should be adjusted. Over the past decade, the global economy has been exposed to shocks many times. These problems have adversely affected its development indicators. According to the UN World Economic Situation and Prospects 2015, under the impact of the global financial crisis, most countries' GDP growth has fallen to a record level compared to the pre-crisis period, although in recent years, individual economies have shown a recovery trend after the Great Recession [23]. 51

ІI. Monetary and Credit Policy mechanism

Figure 13. Directions of the monetary policy Source: composed basing on presented material

IMF in October this year, the following information was published: «The IMF foresees a reduced global growth and warns that economic stagnation may trigger calls for protectionism: − reduced world growth at 3.1 percent in 2016, its increase to 3.4 percent next year − chronic stagnation in advanced economies can cause an increase in the sentiment of opponents of world trade that will restrain economic growth − Countries need to apply all levers of policy – monetary, fiscal, structural – to improve the prospects for economic growth» [26]. Based on the above information, it can be determined that the implementation of an effective monetary and credit policy is one of the key ways to smooth out the crisis consequences and form sustainable growth. Recently, the financial and economic communities of many countries have faced a number of phenomena in their economies that 52

2.2. Directions of the Monetary and Credit Policy

adversely affect both economic growth and business activity of the subjects. The most frequently mentioned reasons in the media are the fall in oil prices, depreciation of currencies (national and partner countries), shocks in international financial markets, growth or fall in prices for goods and services, political instability in certain regions. These trends have an impact on domestic sectors of the economy. At the same time, the nature of the most risk is the money and credit markets, which are the most liquid and therefore more sensitive to changes in the market environment. One of the main indicators for assessing the current situation and the macroeconomic outcomes is the level of inflation. According to the World Economic Outlook, issued in October 2016 by the IMF, the inflation rate has significantly decreased in many economies in recent years, reaching record values from the 1990s to 2016. Among the reasons mentioned, the drop in prices for services, goods and raw materials, primarily oil products. However, it should be noted that inflation, inflationary risks and inflationary expectations are increasing in developing unstable economies, despite a general drop in world prices. At the same time, in some developed countries, there is a deflation or disinflation, manifested in a decrease in the price level below the zero mark. In both cases, there are significant risks and consequences for economic development [24]. Any central bank, its standard set of instruments – the so-called direct impact on the money and credit markets, including the refinancing rate, reserve requirements, open market operations, issuance of own debt instruments. Together, these tools, together with other measures applied by the first-tier bank, determine its policy regarding the promotion of development and stability of the monetary and credit system, the financial system, and the economy. In general, the steps taken should be aimed at stimulating economic growth. In addition, global and domestic challenges dictate the need for monetary policy adjustments, the application of instruments that ambiguously affects economic processes and sectors in different time frames, be they short, medium or long term. Not all measures have a favorable effect on the activities of entities, the social sphere or contribute to economic growth. They can have both positive and negative effects. 53

ІI. Monetary and Credit Policy mechanism

Some examples from «modern life»: − We manage inflation – so stabilize prices, but slow down economic growth; − We devalue the currency – guard the gold and currency reserves, stimulate the export of domestic producers, but contribute to raising the level of dollarization and distrust of the national currency; − we tighten the interest policy – reduce inflation, stabilizing prices, but loose the availability to capital; − We reduce the interest rate (accounting / refinancing, basic and other types of rates) – increase the availability of capital, but can not keep inflation under strict control. The presented list is unlimmited. Therefore, when applying strict monetary policy methods to prevent negative trends, a set of measures is developed and implemented to support the most vulnerable sectors and strategic subjects. Questions for self-control 1. What is the content of the monetary policy directions? 2. What are the types of monetary policy? 3. What is the peculiarity of issuing and withdrawing cash from circulation? 4. How is the «tight» monetary policy characterized? 5. How is the «soft» monetary policy characterized? 6. What are the features of credit expansion and credit restriction? 7. How do the directions of monetary policy affect inflation, employment and economic growth? Working materials Task 1. Specify types of monetary policy. № 1 1.

Direction 2 Mild/soft

2.

Tight/hard

3.

Restrictive

Purpose and Tasks 3

54

Description 4

Measures 5

2.2. Directions of the Monetary and Credit Policy 1 4.

2 Expansion/ stimullating

5.

Expensive

6.

Cheap

3

4

5

Task 2. Specify central banks’ priorities in different countries: 1. Great Britain 2. Spain 3. Italy 4. Germany 5. North Korea 6. Brasil See also attachemets 9-14.

2.2.2. Regimes of the Monetary and Credit Policy The central bank has the right to determine for itself the ultimate goal of monetary policy. This can be inflation indicators, the level of the exchange rate, macroeconomic indicators. Depending on these goals, the following monetary policy regimes are shown in Figure 14:

Figure 14. Regimes of the monetary and credit policy Source: composed basing on [5]. 55

ІI. Monetary and Credit Policy mechanism

These regimes are one of the main ones and are used by central banks in different countries, depending on their medium- and longterm tasks. Figure 15 describes the mode of exchange rate targeting. The fixing of the exchange rate may occur with respect to a clearly established exchange rate value or in the form of a range of deviation. If it is impossible to maintain set value, devaluation is carried out as a reduction in the established indicator. Devaluation is a tough measure conducted by the first tier banks in crisis conditions. Such a measure has a negative impact on economic entities. It is possible to adjust the benchmark in the direction of appreciation of the national currency, taking into account the situation on the domestic foreign exchange market.

Figure 15. Exchange rate targeting Source: composed basing on [5]

Figure 16 aggregates:

describes

the

mode 56

of

targeting

monetary

2.2. Directions of the Monetary and Credit Policy

Figure 16. Monetary aggregates targeting Source: composed basing on [5, 22].

Figure 17. Regime of the monetary policy without establishing a «nominal anchor» Source: composed basing on [5] 57

ІI. Monetary and Credit Policy mechanism

Target benchmarks of monetary aggregates can be used by the central bank as key indicators of monetary policy. Taking into account the necessity, corrective measures are taken to expand or narrow the monetary base and monetary aggregates. Figure 17 describes the regime of monetary policy without establishing a «nominal anchor». In this regime, the central bank sets macroeconomic priorities for the implementation of monetary policy. Therefore, tools are chosen helping to promote economic growth, employment and low inflation. Figure 18 presents a description of the inflation targeting regime.

Figure 18. Inflation targeting regime Source: composed basing on [5]

The regime of inflation targeting promotes the formation of stable money and credit market in the medium term. Detailed information on regimes also in attachements 1-8 to the tutorial. Despite a clear distinction between regimes and their objectives, central banks assess all the indicators in their arsenal in order to develop and use the most optimal set of tools that correspond to the current state of the economy and plans for the future. Questions for self-control 1. What do the monetary policy regimes represent? 2. What are the features of the inflation targeting regime? 3. What are the features of the exchange rate targeting regime. 58

2.2. Directions of the Monetary and Credit Policy 4. What are the features of the targeting regime of monetary aggregates? 5. What are the features of monetary policy «without a nominal anchor»? 6. Identify the main instruments of monetary policy when using the exchange rate targeting regimes and inflation targeting? 7. What are the objectives of the central bank in determining a particular monetary policy regime? Working materials Task 1. Specify regimes of monetary policy. № 1. 2.

3. 4.

Direction Exchange rate targetting Money aggregates targetting Policy without nominal anchor Inflation targeting

Purpose and Tasks

Description

Measures

Task 2. Specify monetary regimes in different countries: №

Country

1 1.

2 Kazakhstan

2.

Russia

3.

Ecuador

4.

Egypt

5.

Denmark

6.

Equatorial Guinea

Bank’s Name

Purpose and Tasks of monetary policy 4

3

59

Regime

Target indicators

5

6

ІI. Monetary and Credit Policy mechanism 1 7.

2 Finland

8.

France

9.

Saudi Arabia

10.

Ucrain

11.

USA

12.

Canada

13.

Gabon

14.

Gambia

15.

Georgia

16.

Germany

17.

Ghana

18.

Greece

19.

Grenada

20.

Guatemala

21.

Guinea

22.

Guinea-Bissau

23.

Malaysia

24.

Kenya

25.

Luxembourg

26.

Korea, North

27.

Korea, South

28.

Kuwait

3

4

60

5

6

2.3. Instruments of the Monetary and Credit Policy 1 29.

2 Honduras

30.

Hong Kong

31.

Hungary

32.

Brasil

33.

Spain

3

4

5

6

2.3. Instruments of the Monetary and Credit Policy Instruments of monetary policy are used by central banks to form a stable money supply and achieve an effective balance in the money market. The standard instruments of monetary policy are presented in Figure 19:

Figure 19. Instrument of the monetary and credit policy Source: composed basing on [22, с. 460]

1. Interest policy. In the Money theory, the price of capital is interest rate. However, given the wide range of financial instruments on the market, there is no one single interest rate that would cover the whole variety of capital forms and the money supply. Taking into account all these features, interest policy is implemented, aiming to provide formation of an 61

ІI. Monetary and Credit Policy mechanism

average level of interest rates in economy for various financial instruments. To study the nature of interest rate policy, it is necessary to identify financial instruments for which it can be efficient and effective. The Central Bank influences the interest rates of the monetary and other financial markets either directly or indirectly, namely: I. Interest rates, set by the central bank. The interest rates set by the central bank include – the discount rate, or the refinancing rate. This rate is applied by the first tier bank of the country in lending operations to second-tier banks in order to replenish internal liquidity on the market. The discount rate serves as a benchmark for setting market interest rates on other financial instruments. In addition, an increase in the discount rate leads to a rise in the cost of credit resources for second-tier banks. In turn it reflects degree of the domestic money market. In the context of the «expensive money» policy, central banks raise the discount rate. In order to improve the business activity of market entities, as well as to stimulate lending, central banks reduce the discount rate and increase the volume of banks financing. The effect of changing the refinancing rate extends to the short and medium term. To be able to predict the cost of capital, central banks declare a target benchmark at the discount rate or the corridor of its possible deviation. Another type of interest is the base rate, which is also set by the central bank. This rate does not apply in transactions between a bank of banks and financial market entities, but it is a general indicator of market money price. The base rate can be changed on a monthly basis through its public disclosure by the first-tier bank. The Central Bank determines the rate for its own short-term obligations issue for a period of up to 12 months, that institutional investors invest. Such liabilities relate to highly liquid low-risk and reliable assets. With the help of its own obligations, the first-tier bank removes excess short-term liquidity from the economy. The issuance of obligations is seen as a tightening of monetary regulation. If necessary, these instruments can be repaid ahead of schedule. 62

2.3. Instruments of the Monetary and Credit Policy

The bank of banks attracts deposits from second-tier banks, the percentage of which is a directively set rate. II. Interest rates of the debt market. The debt market is one of the key segments of the country's financial sector. In the debt market, the following markets can be distinguished: − bank loan operations; − repo-operations market; − interbank loans; − corporate bonds; − government securities, including short-term liabilities of the central bank. In all these submarkets, except for the central bank's own short-term obligations, market pricing mechanisms is valid. The interest rate is established under the influence of supply and demand. The equilibrium percentage can be formed by other macroeconomic, internal and external factors, for example, financial risks, investor expectations, inflationary and devaluation expectations. However, within the monetary regulation framework, the central bank intervenes in market processes by creating additional demand or supply. Above all this concerns repo transactions, based on government and corporate securities, in which a first-tier bank becomes a participant in transactions for the purchase or sale of financial instruments. III. Interest rates of the deposit market. On the deposit market, there are: – deposits of economic entities placed in financial institutions, primarily in second-tier banks – interbank deposits – deposits of second-tier banks in the central bank. Formation of interest rates for the first two types of deposits relates more to the market mechanism. However, the bank of banks sets benchmarks for the value of money in the economy, such as the discount rate and the base rate, which indirectly affect the annual interest rate on deposits. 63

ІI. Monetary and Credit Policy mechanism

2. Norms of reserve requirements. In order to reduce risks in the banking system, as well as the implementation of monetary regulation, the central bank applies reserve requirements. This is the norm of reserves for liabilities of second-tier banks – internal and external, in national and foreign currency. The reserve ratio is set in the form of a percentage of the amount of the bank's liabilities and is constantly recalculated. Formed reserves are stored in the accounts of second-tier banks in the central bank (in national currency) or in correspondent banks (in foreign currencies). The reserve norms allow to reduce credit risks by default of the bank's obligations to its clients. The reserve coveres almost all types of obligations – attracted deposits, loans received, money on current accounts and demand accounts. The central bank can establish a single reserve rate or differentiate it according to the degree of risk – short-term, medium-term, longterm; Internal (to residents) and external (to non-residents); in national and foreign currencies. From the point of view of monetary policy, the increase in the reserve ratio reduces the level of money supply, that is, the level of the actually available volume of financial assets of all commercial banks that they can use in their activities to finance the economy. Such a measure refers to a restrictive – restraining policy. Reducing the norm of reserve requirements increases the volume of liquid assets in the banking sector and refers to expansionist-stimulating policies. 3. Open market operations. In the case of soft/mild monetary policy, the central bank purchases financial instruments, thereby replenishing liquidity in the market. If it is necessary to limit the amount of money supply, the central bank sells financial instruments to market participants, withdrawing excess money supply. Operations on the open market are: − purchase and sale by the central bank of government securities of domestic and foreign issuers; 64

2.3. Instruments of the Monetary and Credit Policy

− repo transactions; − purchase and sale of foreign currency in the domestic market; − currency swap transactions. In addition to the domestic market, central banks actively conduct operations on international and foreign financial markets. This activity can refer to the formation of gold reserves or to cross-border and integration policies in the region. 4. Corrective measures of the central bank The central bank conducts constant monitoring of the money market and macroeconomic indicators. As a result, the country's first bank develops a set of measures corresponding to the priorities of the national economy and the market itself, namely: I. To stimulate business activity and revive the economy, measures are being taken to increase the availability of money for economic entities, including increasing the supply of financial assets on the market, reducing the level of interest rates – naturally or with the participation of the central bank. However, at a certain stage, stimulation can lead to «overheating» of the market and the economy. When money is too much, they lose their value, which is manifested in the growth of inflation and / or the exchange rate of the national currency. In turn, the availability of available capital leads to overproduction of goods, works and services, which are also depreciated due to a lack of demand for them, that is, a limited level of consumption. II. In case of a threat of «overheating» of the market or overproduction, the central bank intervenes in market processes, limiting the availability of financial resources – their volume, and also increases the interest rate on the market. The demand of economic entities for money is reduced, as a result, the growth of inflation and / or the exchange rate of the national currency is suspended. However, such measures lead to a decrease in business activity and impede economic growth, so the bank of banks adjusts its rate of restriction by further easing. 65

ІI. Monetary and Credit Policy mechanism

In the event of an imbalance in the money market or the emergence of such a threat, the central bank affects the supply of money in the following ways: − by directly changing the volume of supply, participating in market transactions − by providing resources to the banking sector or attracting deposits from STBs − by indirectly changing the volume of the offer, increasing or reducing restrictions on reserves and other capital requirements for commercial banks − by changing interest rates, leading to an increase or decrease in the price of money in the market. III. When implementing monetary policy, the central bank estimates the level of the national currency exchange rate. If necessary, corrective measures are taken in the form of currency interventions or currency restrictions. The central bank influences the level of demand and supply of foreign currency on the domestic market, thereby stimulating its appreciation or cheaper. Thus, in order to insure sustainable growth different monetary instuments are widely used by central banks. The central bank conducts constant monitoring of the money market and macroeconomic indicators. As a result, the country's first bank develops a set of measures that correspond to the priorities of the national economy and the market itself. Questions of self-control 1. 2. 3. 4.

What is the discount rate? What is the peculiarity of accounting policy? What is the essence of interest policy? What tools does the central bank use when conducting operations on the open market? 5. What are the main assets of open market operations? 6. What is the peculiarity of the formation of gold and foreign currency reserves? 7. What are the goals and objectives of reserve requirements? 66

2.3. Instruments of the Monetary and Credit Policy Working materials Task 1. Determine instruments of monetary policy. №

Direction

1.

Interest rates

2.

Reserve requirements

3.

Open market operations

4.

Gold and Foreign currency reserves

Purpose and Tasks

Description

Levels / volume

Task 2. Specify instruments of monetary policy in different countries: №

Country

1 1.

2 Kazakhstan

2.

Russia

3.

Ecuador

4.

Egypt

5.

Denmark

6.

Equatorial Guinea

7.

Finland

8.

France

Instruments

3

Purpose and Tasks of used istruments 4

67

Type of monetary policy 5

Target indicators 6

ІI. Monetary and Credit Policy mechanism 1 9.

2 Saudi Arabia

10.

Ucrain

11.

USA

12.

Canada

13.

Germany

14.

USA

3

4

5

6

2.4. The Implementation of Monetary Policy Under the Influence of External Factors Each economy and its money market are affected by the external world. Integration and globalization processes make adjustments to conduct monetary policy and complicate the activities of central banks. Open markets promote free flow of capital in two directions from outside to the domestic market and from the domestic market to the outside. The development of international financial markets has a multiplier effect on what happens to internal and external processes, facilitates the flow of money or their outflow mainly in foreign currency. The inflow of money leads to an increase in the volume of the offer, primarily in the foreign exchange market. The outflow of money affects the fall of this amount. A similar situation concerns the import and export of goods, works and services, which are related to the conduct of corresponding payments, mainly in foreign currency. Financial crises are spread, first of all, through the capital markets – the monetary sectors are most exposed to shocks. The short-term money market is very sensitive to external influences, including changes in the interest rate, the exchange rate of the national currency and the corresponding changes in the volume of supply and demand. 68

2.4. The Implementation of Monetary Policy Under the Influence of External Factors

The presence of speculative and arbitrage transactions on the one hand increase the liquidity of the markets, on the other hand, they contribute to the growth of the level of risks. Foreign counterparties, foreign financial organizations and foreign investors operate on the money market, creating additional demand and supply for money within the economy. Domestic subjects enter foreign money and credit markets, forming the flow of flows between countries. All these facts have a significant impact on monetary policy. The role of the central bank is to ensure proper control over the flow and movement of money between domestic and foreign markets, as well as to implement protectionist measures to ensure financial stability inside the country. In addition, the first-tier bank should predict and model the effects of external influence in order to prevent negative developments and create conditions for the proper development of the monetary and financial system. All instruments of monetary policy should be adjusted taking into account the integration of the domestic market into the international money and credit markets. Proceeding from the set tasks, the central bank estimates the indicators of payment and trade balances. Currency exchange regulation and control are mandatory. Balance of payments accounts reflect transactions of the national economy with the economies of other countries [19]. The balance deficit arises from the excess of outflows of money over their receipts. In the context of monetary policy, which provides for regulation or fixing of the exchange rate, the central bank carries out measures to fill the lack of funds. With a positive balance of payments, the first-tier bank has the ability to replenish reserves in the domestic market. Central banks of different countries have reserves – stocks of foreign currency, precious metals and other liquid assets. Reserves can be replenished on domestic and foreign markets. Assets are used to maintain the stability of the domestic currency market – Figure 20. 69

ІI. Monetary and Credit Policy mechanism

Figure 20. Corrective measures of the central bank on the foreign exchange market Note: composed basing on presented material

If there is a surplus of foreign currency on the domestic market, its acquisition is carried out by exchange and over-the-counter methods. Otherwise, central banks sell part of their reserves to maintain the required level of supply of foreign currency needed for business agents – figure 21. The necessary volume of interventions is determined by the state of the balance of payments [19]. However, the gold and foreign currency reserves can be depleted, in such conditions, not leading to a critical point, central banks stop their intervention and move to a new equilibrium state of the money market [19]. The methods described above refer to the fixed exchange rate regime. At the same time, some central banks of the world, primarily developed countries, carry out a policy of flexible exchange rates, which presuppose the least interference in the formation of demand and supply of foreign currency. Conventional swimming is not absolute, but refers to an adjustable voyage. 70

2.4. The Implementation of Monetary Policy Under the Influence of External Factors

Figure 21. Corrective measures of the central bank Note: composed basing on presented material

The monetary authorities of the country provide cooperation with the central banks of the partner countries and the countries-participants of integration associations. Depending on the level of integration of the state, the directions of monetary policy take into account the interests of regional development. For this purpose, first-tier banks agree on target indicators and measures taken to ensure the stability of domestic markets. Central banks in their policy take into account the fact that globalization processes, along with positive economic effects, have negative consequences and contribute to the emergence of additional risks in the national market. For example, the emergence and spread of financial crises in international markets leads to a «domino effect» localizing on domestic financial markets. The degree of influence of threats is determined by the effectiveness of monetary policy. Thus, monetary policy necessarily takes into account the external economic factors, the situation on international markets with 71

ІI. Monetary and Credit Policy mechanism

the aim of protecting and stimulating the domestic market, as well as ensuring the country’s economic integration into the world community. Questions for self-control 1. What is the impact of external factors on the economy of the country? 2. How is the monetary policy implemented in the context of integration and globalization processes? 3. What is the purpose and objectives of the central bank in conditions of instability of international markets? 4. What indicators does the central bank use to assess the external impact on the domestic market? 5. What are the goals and objectives of the formation of reserves by a first-tier bank in an open economy? 6. What monetary policy instruments are used to correct external threats? 7. What instruments are used by central banks to ensure the stability and stability of the domestic money market in the spread of global financial crises?

Working materials Task 1. Determine external and internal factors that affect on money and credit market. №

Factor

1.

External – …

2.

External – …

3.

External – …

4.

Internal – …

5.

Internal – …

6.

Internal – …

Description

Effect

72

Measures

2.4. The Implementation of Monetary Policy Under the Influence of External Factors Task 2. Present information on national currency in different countries: №

Country

1 1.

2 Kazakhstan

2.

Russia

3.

Ecuador

4.

Egypt

5.

Denmark

6.

Equatorial Guinea

7.

Finland

8.

France

9.

Saudi Arabia

10.

Ucrain

11.

China

12.

Canada

13.

Gabon

14.

Gambia

15.

Georgia

16.

Germany

17.

Ghana

18.

Greece

Currency Name

Type of convertation

3

4

73

Regime of Monetary policy 5

Exchange rate to US$ 6

ІI. Monetary and Credit Policy mechanism 1 19.

2 Grenada

20.

Guatemala

21.

Guinea

22.

Guinea-Bissau

23.

Malaysia

24.

Kenya

25.

Luxembourg

26.

Korea, North

27.

Korea, South

28.

Kuwait

29.

Honduras

30.

Hong Kong

31.

Hungary

32.

Brasil

33.

Spain

34.

Nigeria

35.

Pakistan

36.

Qatar

37.

Trinidad and Tobago

3

4

74

5

6

3.1. Main particularities of the Monetary and Credit Policy of the Republic...

III. MONETARY AND CREDIT POLICY OF THE REPUBLIC OF KAZAKHSTAN 3.1. Main particularities of the Monetary and Credit Policy of the Republic of Kazakhstan The autonomous monetary policy in the Republic of Kazakhstan is realized from the moment of gaining independence. The prerequisites for its formation were reforms in the early 1990 s. and the transition to a market economy. The body responsible for the development and implementation of monetary policy is the NBK. The figure shows the main stages of this policy, identified by the bank of the first level, taking into account the historical development and cyclical nature of the economy – figure 22.

Figure 22. Inflation targeting monetary policy Note: composed basing on [5] 75

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

Let's consider each stage separately, proceeding from an economic conjuncture which existed at this stage, the list of applied tools, and also the reached results. The first stage of 1993-1999 was the most important and critical, which was discussed by the following factors presented in Figure 23:

1993 – 1999 г.

Figure 23. Prerequisites for formation of the MCP in 1993–1999 Note: composed basing on [5]

The economic crisis predetermined the need for introducing a tight monetary and credit policy for the stabilization of the domestic 76

3.1. Main particularities of the Monetary and Credit Policy of the Republic...

market. The list of used tools and the results of their use are shown in Figure 24.

Figure 24. Instruments of MCP in 1993–1999 Note: composed basing on [5] 77

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

The next stage is characterized by an improvement in the internal conjuncture, which is shown in Figure 25 below. As a result of application of adjustments of the monetary-credit rate taking into account the favorable external environment, significant results were achieved in the economic recovery of the country. The next stage of 2007-2013. is characterized by a recession in the economy, a decline in growth rates and an increase in inflation against the backdrop of the global financial crisis, as well as worsening of the situation on the international and domestic markets. Information on the situation, instruments of monetary policy and its results is presented in Figure 26 below. In this period, despite the growth of inflation, the NBK pursued a policy of «cheap money» in order to maintain liquidity in the market and the availability of funds for economic entities.

78

3.1. Main particularities of the Monetary and Credit Policy of the Republic...

Figure 25. Instruments of MCP in 2000–2006 Note: composed basing on [5] 79

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

80

3.1. Main particularities of the Monetary and Credit Policy of the Republic...

Figure 26. Instruments of MCP in 2007–2013 Note: composed basing on [5]

Since 2014, the policy of «cheap money» has been changed in terms of raising the level of interest rates and, as a consequence, appreciation of credit resources. Another significant fact was the change in the regime of monetary policy from the targeting of the exchange rate to the targeting of inflation. In this period, the national currency was devalued. The exchange rate began to be formed more market – under the influence of supply and demand with the minimum possible participation of the central bank in operations in the open foreign exchange market. Information on the situation, instruments of monetary policy and its results at this stage is presented in Figure 27 below. Currently, the benchmarks defined in the Monetary Policy of the Republic of Kazakhstan until 2020 are used. According to the document, the NBK follows the inflation targeting regime, but the inflation rate remains quite high. Devaluation expectations, instability of the exchange rate of the national currency in 2015-2017. lead to additional pressure on the subjects. Annex 1 presents the modeling and forecasting system used by the NBK in the conduct of monetary policy. 81

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

82

3.1. Main particularities of the Monetary and Credit Policy of the Republic...

Figure 27. Instruments of MCP in 2014–2015 Note: composed basing on [5]

In general, monetary policy since 1993 can be described as sufficiently flexible and appropriate for the domestic and foreign markets. However, in some cases, the rigidity and harshness of policies leads to a deterioration in the economic condition of the population, enterprises and financial organizations. The measures taken by the central bank in most cases make it possible to smooth out the money market's inconsistency only partially. Questions for self-control 1. What are the prerequisites for the introduction of a monetary monetary policy in the early 1990s? 2. What are the features of the introduction of the national currency – tenge? 3. What are the specific features of the monetary and credit policy of the Republic of Kazakhstan in the 1990s? 4. What are the main instruments of the monetary and credit policy of the Republic of Kazakhstan in the early 2000s? 5. What are the main instruments of the monetary and credit policy of the Republic of Kazakhstan in 2007-2013? 6. What are the main instruments of the monetary and credit policy of the Republic of Kazakhstan in 2014-2016? 83

ІII. Monetary and Credit Policy of the Republic of Kazakhstan 7. What is the current state of the monetary and credit system of the Republic of Kazakhstan? Working materials Task 1. Specify monetary policy in Kazkahstan. Year 1

Purpose and Tasks 2

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 84

Description 3

Measures 4

3.1. Main particularities of the Monetary and Credit Policy of the Republic... 1

2

3

4

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Task 2. Determine type and regime of monetary regimes in Kazahstan: №

Period

1.

1991-1992

2.

1993-1999

3.

2000-2006

4.

2007-2013

5.

2014-2015

6.

2016

7.

2017

Type

Purpose and Tasks of monetary policy

85

Regime

Target indicators

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

3.2. Analysis of the effectiveness of monetary policy instruments The instruments of the NBK's policy are aimed at the money, currency, credit and deposit markets. The sphere of influence remains investment resources, namely, the availability of capital for economic entities. The situation can be presented in the form of a model in which the effect of the measures used is spread by a cascade along the chain: the central bank – the financial market – the second-tier banks and nonbanking organizations – the subjects of the economy. Relatively recently, the central bank introduced an inflation targeting regime, which should be expressed in keeping inflation (up to 3-4% in the medium term). The transition to the specified regime provides for the rejection of currency targeting, that is, the refusal to fix the exchange rate in relation to other currencies, primarily to the US dollar [5]. In international practice, inflation targeting involves the use of a flexible exchange rate, which is formed on the basis of demand and supply in the foreign exchange market. The positive effect in the form of a decrease in the use of gold and foreign currency reserves, as well as support for export-oriented industries, does not fully cover the needs of the economy. The transition from currency targeting in 2015 became a kind of stress for domestic economic entities, culminating in the next devaluation of the national currency and speculative transactions with the major currencies in this market. Currency shocks continue to experience those industries where there is a great dependence on the import of goods, works and services. The result is a rise in the cost of groups of goods and services for end users, a decrease in the volume of aggregate demand in physical terms, a drop in consumption. What could have an additional negative impact on the national economy with a lag in the medium and long term. Another negative effect was the increase in the population's mistrust towards the tenge. A significant portion of the population's savings placed in the form of deposits in STBs was transferred from the national currency to US dollars for the previous biennium. Devaluation expectations continue to grow, despite periods of strengthening the national currency. The change in the base interest 86

3.2. Analysis of the effectiveness of monetary policy instruments

rate and, accordingly, the deposit rates, has little effect on the current situation. One of the reasons is high inflation, where deposit rates do not cover the level of depreciation of the national currency. In addition, currency arbitrage, formed as a result of the appreciation of the dollar-tenge currency pair, significantly exceeds the yield on deposits in tenge. The domestic central bank, having defined inflation targeting as the key regime of monetary policy, in its way challenges itself. This regime provides for ensuring and maintaining the purchasing power of the national currency at the proper level. According to officially published data of the NBK in September 2016, inflation in our country was 16.6% with a medium-term inflation target of 6-8% [28]. It is practically impossible to form a price stability without the formation of import substitution. For the development of importsubstituting industries, investment resources are required. At the same time, it is necessary to pay attention not only to the availability of such resources, but also to their availability. Enterprises are adversely affected by the policy of increasing the cost of capital – interest rates, which can exacerbate the slowdown in their business activity. Also, the problem of the lack of reliable and stable borrowers from among economic entities that have suffered financial and currency shocks continues to persist, and has not fully recovered from the shocks of 2007-2008. Of course, the state is trying to support certain sectors / industries through the implementation of various programs, but such programs lead to an additional burden on the country's budget, spending funds from reserve funds, increasing liquidity in the banking sector. The result is a significant volume of demand in the exchange market in the repo, swap and spot transactions sectors, indicating large operations of banks with short-term liquid assets (see Table 3); growth of indicators of monetary aggregates (see Table 4); high rate of inflation. According to the table, the trading volume grew by 10% in nine months this year compared to the same period in 2015. In the framework of the current policy on minimal interference with the market pricing of the exchange rate of the national currency, as well as 87

ІII. Monetary and Credit Policy of the Republic of Kazakhstan

other measures to stabilize it from the central bank, there is a decrease in the volume of transactions with foreign currency by 22 trillion. tenge. Table 3 The volume and structure of the market of the Kazakhstan Stock Exchange (nine months) Bln tenge Sector of stock exchange

1-9, 2016

1-9, 2015

Trend

Volume

%

Volume

%

Volume

%

Foreign currency

27 349,0

37,4

49 454,8

74,4

-22 105,8

-44,7

– spot

7 945,9

10,9

8 188,7

12,3

-242,8

-3,0

– swap

19 403,1

26,5

41 266,1

62,1

-21 863,0

-53,0

Kz state bonds

415,8

0,6

396,5

0,6

19,2

4,8

– initial market

218,2

0,3

389,6

0,6

-171,4

-44,0

– secondary market

197,5

0,3

7,0