Monetary policy: Implementation in the money market
The video ‘Monetary policy: Implementation in the money market’ presents key terms and concepts. The following exercises will help you better understand and consolidate them.
A summary of the video’s key points, supplemented by selected illustrations from the video, is provided to assist you.
In the following, the term ‘central bank money’ will be abbreviated to CBM.
Getting started with the video
Before tackling this worksheet, please watch the video ‘Monetary policy: Implementation in the money market’:
Is there anything in the video that seemed particularly clear, or perhaps particularly difficult to understand?
Exercises in connection with the video
Most central banks – the Swiss National Bank included – pursue their monetary policy goals by exerting a strategic influence on the economy. Under normal circumstances, this is primarily achieved by adjusting the key interest rate. The SNB refers to its key interest rate as its ‘policy rate’.
In one or two sentences, describe what the function of the policy rate is at the SNB.
The diagram below shows a simplified representation of a commercial bank’s balance sheet on the left. The balance sheet is divided into assets (held by the bank) and liabilities (obligations entered into by the bank).
A commercial bank’s business model is essentially simple: it receives money from customers (e.g. as savings deposits) and lends this money as loans to other customers, such as companies or individuals. A bank makes money by charging higher interest on loans than it pays on customer deposits.
Answer the following questions:
Why are customer deposits on the liabilities side of the balance sheet? Explain briefly.
Why are the loans shown on the assets side? Give your reasons briefly.
Why does a commercial bank need CBM? Give arguments.
The diagram above shows a simplified representation of the SNB’s balance sheet on the right. This balance sheet is also divided into assets (held by the SNB) and liabilities (obligations entered into by the SNB).
Answer the following questions:
Why is the CBM on the liabilities side of the SNB’s balance sheet? Give arguments.
What function do investments (gold, foreign currency investments, etc.) perform on the assets side of the SNB’s balance sheet? Explain.
What does a commercial bank do if it has too little CBM? Explain.
The average interest rate at which short-term trading on the Swiss franc money market takes place within a given day is called SARON (Swiss Average Rate Overnight). Name the two factors that determine this interest rate.
How does the SNB ensure that SARON remains close to the policy rate? Explain.
Consider the following diagram. It depicts the transmission process of monetary policy from the policy rate via the short-term money market rates to the interest rates that drive consumption and investment decisions made by households and companies (loan rates, savings rates, mortgage rates, etc.), and finally to those consumption and investment decisions made by households and companies, as well as the general price level.
Explain in your own words the challenges to implementing monetary policy. Focus on the part of the diagram that is highlighted by a dotted line.
Answer only one of the following questions (a or b):
Describe as precisely as possible the SNB’s monetary policy response when the economy booms and inflation increases. In your answer, use the terms policy rate, open market operations, CBM, money market interest rates, loans and prices.
Describe as precisely as possible the SNB’s monetary policy response when the economy grows more slowly and inflation decreases. In your answer, use the terms policy rate, open market operations, CBM, money market interest rates, loans and prices.
What would happen if central banks were unable to steer money market rates? Explain briefly.
