Research Topics: Monetary Policy

Brazil and its Financial Sector

Brazil and its Financial Sector Executive Summary             Through the efforts of the local administration in order to sustain its financial sector, Brazil was able to encounter significant development. In particular, its government enforced several controls and the tight monetary policy in order to address its budgetary deficit. Despite this, increasing the interest rate to lower the inflation rate and defend the real led to certain problems. One of the major financial issues faced by the country is the devaluation of its currency. Not only had this affected the local economy but the economies of other neighboring countries as well. Based on the gathered data and analysis, the current financial concern of Brazil did not originated from its initial decisions but on its failure to take a proactive approach on the rising consequences of these financial decisions. The government should have taken the appropriate actions before it had lost billions of reserves and lost its credibility. It has then been suggested that the Brazilian government should either abandon its attempt to regulate the exchange or manage and fix the exchange rate without managing the local currency, which can be done through a currency board. In general, the plan of the government to resolve the issue should be directed on the restoration of the investors’ and people’s confidence to the government as well as the re-establishment of the credibility of its financial system.   Introduction The monetary policy is defined as the economic terms pertaining to government actions related to the setting of public expenditure and how these expenditures will be supported. Governments utilize the policy in influencing the aggregate demand level; the purpose of which is to fulfill economic objectives including economic growth, full employment and price stability. There are a number of policy types. One of which is the contractionary monetary policy, which is characterized by reduced public spending or increased taxation. This type is also known as tight monetary policy. The main purpose of implementing this type of policy is to increase the interest rates. This in turn will help in controlling inflation, increasing the exchange rate as well as attracting foreign currencies. Such policy however, also has some drawbacks. In particular, this could reduce the money level in the economy for consumption, resulting to decreased demand and spending as well as increased pressure on prices. Governments implement such policies in order to sustain the local currency and their countries’ financial state. In Brazil, its president has chosen to implement the tight monetary policy so as to defend the real. In this discussion, the different aspects of Brazil’s previous and present financial status are described. The reactions of various economic aspects to the local administration’s decision to implement this type of policy are also explained using facts and theories. Finally, recommendations or the probable courses of action the government could take to resolve its financial issues are provided.             Brazil and its Monetary Policy: Fact and Effects President  maintained the tight money policy in order to support the real as well as prevent the trade deficit from going out of control. The main purpose of implementing a tight money policy is to increase the interest rates. This in turn will help in controlling inflation, increasing the exchange rate as well as attracting foreign currencies, which can be useful in controlling current account deficit ( 2004). Though this may have resolved the economic problem of the country, the government also has the alternative of implementing a loose or expansionary monetary policy. The aim of such policy type is to stimulate the aggregate demand. This is typically done when the government thinks that that the unemployment in the country is too high or if the economy is not progressing fast enough. A loose fiscal policy then allows the people and businesses to have more spending money to make purchases. This in turn helps in generating demand as well as job opportunities, leading to economic growth and higher employment ( 2006). By applying the tight monetary policy, the short term interest rates of the country will increase more that the long term rates. This is because tight monetary policy tends to reduce money level in the economy for consumption, resulting to decreased demand, spending and pressure on prices ( 2006). The short term capital cost is then driven up by the shortage of money and credit. Long term interest rates on the other hand stay low when this occurs. This is because foreign investors expect the monetary policy to loosen and the inflation to decline. Due to low long term rates, tight monetary policy then increases the demand for long term bonds. Despite the effort of the Brazilian government, financial issues still arise such as the falling interest rates. One of the main causes of the decreasing interest rates in Brazil for the past years is the investment sector. It is known that when the interest rate increases, the investment rate decreases. When this happens, reduction of investment spending increases; this trend then follows the principle that as consumption and demand decreases, the aggregate demand curve will shift to the left, implying a contracting economy. However, for the past years, foreign investment in Brazil had remained strong, causing the interest rate to fall. The country continues to attract foreign investors through its large population as well as its GDP rate. The country has been considered a good site for investment as it has one of the largest markets within the Latin American region. In addition, industrialization efforts are well underway in the country. According to the article authored by  (2000), having a stronger business investment is one of the causes of the country’s growth in the past years, resulting to lowering interest rates. Specifically, both the import and export sectors have remained strong over the years. Having a stable currency, the presence of growth factors and low inflation, the country’s central bank was able to cut the short term interest rate by two percent.   Actions: Benefits and Consequences The growing deficit of the country drove the local administration to take certain actions such privatizing its social security. The privatization of the social security system is said to generate considerable improvements to the country applying it. In a research done by  (1996), the researcher made use of a model in order to determine the effects of social security privatization. The study revealed that the privatization of social security can be useful for producing major increases in living and output standards. Moreover, the gains of privatization are more significant if the resources are redistributed from initial to future generations. Welfare improvement or efficiency gains from privatization are also substantial. This also helps in enhancing the well-being of the lifetime poor relative as compared to the lifetime rich relative. Privatizing social security will also help in improving national savings rate. In privatization, larger fiscal burden is placed on the initial order generation, resulting to a lower fiscal burden for the initial young and future generations. The higher tendency of the initial elderly to consume will then be reduced, resulting to increase national saving, investment as well as real wage growth (1996).  The privatization of the social security system however has some risks as well. In particular, this system would make the workers encounter of financial market underperformance during their working careers. Individual accounts then become vulnerable to unavoidable and large fluctuations in the market. These fluctuations can negatively affect the savings of the retirees. This can be resolved by having long working hours; however, this will also result to significant pressures in the labor market due to lower wage growth as well as high unemployment rates. The national government then acts on this by implementing financial support programs, directing transfers to account holder or expanding social programs. In other words, should the market underperforms, the government would have to pay then creates a system of insured gambling (2006). Aside from social security privatization, the government also made use of various means to control the currency. Using currency controls to defend the real has both benefits and costs. Through these currency controls, upward pressure is observed on price levels; this in turn is useful for reducing inflation. One of the main currency control used by Brazil in order to defend the real is to push the interest rate by almost fifty percent by the central bank. The higher the local interest rates become, the more profitable it is. However, this can only occur if people who place their money on Brazilian savings accounts or purchase depressed Brazilian bonds are certain that the value of their savings in dollar will not be affected by devaluation. This is why the currency control applied through interest rate only resulted to increased costs of private and public servicing debts. The level of these costs became so high that the investors grew certain that problem will occur; this problem was the subsequent collapse of real’s dollar value. The inadequacy of the necessary factors can then cause the currency controls to backfire. In the case of Brazil, the cost of applying currency control to defend the real only resulted to rapid fall of the asset prices within its economy. Other effects include the increased risk and rate of bankruptcy, reduction of the collateral backing existing loans and the placement of the financial system to considerable burdens. The attempts to save Brazil’s financial state and economy encountered several other issues. For instance, speculators had a consensus that the Brazilian currency is overvalued due to the financial situation of the country as well as the status of its financial factors. One of the main reasons for the speculation is the increasing account deficit of Brazil. The foreign exchange reserves of the country are decreasing as well. It is said that currency overvaluation is done by governments in order to lessen the amount of imports in order to finance their countries’ deficits. With this tactic, imported goods become less appealing to the local consumers. Trade sectors also become more narrowed and manageable with an overvalued currency. Currency overvaluation is then an alternative for capital flight; considering the financial state of Brazil, its currency then reached speculation. The Brazilian currency is said to be overvalued by fifteen to twenty-five percent ( 2001).   Choices and Decisions             In accelerating the depreciation or decline of the Brazilian currency, a number of tradeoffs must be considered by the president. One of which is its impact on product prices. Naturally, fast depreciation of the local currency will result to increased inflation. This in turn will cause the price of locally-produced products to increase. The consumption of the imported goods on the other hand will increase. The president should then consider his priorities in terms of addressing budgetary deficit as well as increasing local consumption and investment rate. The rate of real’s depreciation should also consider the local and foreign trade sectors. It has been considered that if the administration has chosen to devalue the currency rather than defend it, these issues would not have been encountered. However, the recessionary impacts in Brazil are not particularly centered on its tight monetary policy, but on the timing of its decision to devalue. Considering the effects of the tight monetary policy, its can be said that this decision has resulted to a number of beneficial effects to the country. Through this, the strength of the country’s investment sector has been restored. Raising the interest rates and privatizing social security helped in covering budgetary deficits. However, it should be noted that this act has also resulted to some negative impacts to Brazil. Slow GDP growth, increase unemployment rate as well as the decreasing quality of the credit services of local banks was some of the notable disadvantages. The image of the president was even marred by the public’s perception that such financial decision was only favorable for the nation’s wealthy sector. With these, recessionary impacts of the monetary policy could have been avoided if the government has acted immediately on it.             The failure of the administration to act immediately further worsened the impacts. When all options were lost, the president and his advisers then decided that devaluation is the solution to the problem. This in turn made matters worst as the government initially pledged that the Brazilian currency will not be devalued. Due to this decision, the credibility of the government was negatively affected. This also reinforced the negative expectations from devaluation of the financial community and markets.   The destruction of the credibility of the government was realized by the central bank, causing its major officials to step down. When the local currency was devalued to about 8.6%a total of .2 billion reserves had already been lost. Upon the resignation of the central bank officials, further billion reserves were estimated to have left Brazil. It was when another billion of reserves was lost did the local government decided to let the currency float freely. Problems are already evident due to the previous financial decision; the government should have taken this signs more analytically. Practical and timely actions then could have been made. With devaluation, the credibility of its government is not the only one affected. The devaluation of its currency can also cause negative effects to the local economy and to other foreign countries as well. The devaluation of the real poses a number of risks to the financial status of several Brazilian corporations, especially those that are exposed to foreign exchange risks. Consider the following example. If Company X is exposed to a high level of foreign exchange risk and also a major client of Company Y that has no of little foreign exchange risk, then any impact that will affect Company X will cause an indirect impact to Company Y. This effect has been observed a number of times within the local economy, firms and financial institutions. The devaluation of the Brazilian currency has also caused credit agencies to downgrade the country’s sovereign debt. In effect, the Brazilian economy will encounter more constricted credit conditions and higher borrowing costs. Other Latin American countries will also be affected by Brazil’s decision to devaluate its currency. This is because most of these nations are very much dependent on capital inflows and foreign investment. Chile, Mexico, Uruguay and Argentina are some of the countries that will be most affected by the devaluation of the Brazilian currency. Except for Chile, the said countries have economies that are dependent on capital inflows. Aside from Brazil, the economy of Argentina will have the most losses, mainly because the investors do not differentiate capital allocation on a country by country basis. Considering the nature of Argentina’s currency board, its strong trade sector is affiliated with the Mercosur nations; due to its inability to implement monetary policy, the country will then encounter major capital outflow, resulting to recession and decreased supply of money.    Conclusion and Recommendations             The Real Plan appears to be the main link between the country’s history of hyperinflation and budget deficits. This plan has been made in order to design economic reforms as well as conduct structural development; in order to carry this out, a .5 billion loan was placed on the International Monetary Fund. This loan was intended to protect the currency from capital flight as well as to boost the country’s dollar reserves. The structural developments included in the Real Plan aimed to break the rising dollar equivalent wages observed in the country’s manufacturing sector, sustain profit rates as well as establish more attractive condition for foreign investment. If all went according to plan, the effects of failing capital asset prices as well as the institutional desperation for dollars will not be experienced. The plan however failed as the supported budget was not acquired; the economic reforms also failed to get through the local legislature. This then led to the implementation of various currency controls so as to address the country’s budgetary deficit.             From the given discussion, it became clear how the decision of Brazil’s local administration had affected its various economic aspects including its GDP, employment and investment rate. While the decision to defend the real through currency controls has helped the country with its budgetary deficit, this had also resulted to some major consequences. From this, the fault is not on the administration’s selected monetary policy but on its reaction rate to arising problems brought about by its decision. In this experience, it has been learned that acting immediately to financial concerns could have saved other neighboring economies and the country from losing considerable reserves.             Despite the financial problems being faced by the country, there are a number of ways on how the President can address the country’s current financial crisis. For instance, the local government can abandon the attempt to regulate the exchange rate; this in turn, will prevent the administration from gambling away the dollar reserves of the central bank in order to keep the currency within the target trading band.  The government may also choose to manage and fix the exchange rate without managing the local currency. This can be done by following the currency board of Argentina; through the currency board, difficult problem brought about by the fixed exchange rate regime can be addressed, leading to a more controlled local monetary growth. This recommendation however may take away the central bank’s ability and flexibility to address economic crises, resulting to greater economic downturns brought about by a freely floating currency. Whatever policy the Brazilian administration plans to implement, it is essential that the people’s and investors’ confidence are regained and the system’s credibility restored. It is essential that the government acts immediately on this financial turmoil before it worsens and affects other neighboring countries.                                                           Credit:ivythesis.typepad.com

Brazil and its Financial Sector

Brazil and its Financial Sector Executive Summary Through the efforts of the local administration in order to sustain its ...

With reference to the Bank of England, explain how monetary policy is implemented

INTRODUCTION First before we tackled on the monetary policy let us view first the background on the Bank of England and know its content. Bank of England, popularly known as the Old Lady of Thread needle Street, its main office stands on the street of that name in London. Bank of England central bank and note- issuing institution of Great Britain. In British Isles, the bank has eight branches all of which are located. Throughout Great Britain and Northern Ireland, although Bank of England notes are legal tender, banks in Scotland and Northern Ireland also issue notes that may be either used as currency themselves or exchanged for Bank of England issues. The Bank of England has sole central banking functions in Great Britain, in all matters beside note issue. The affairs of the bank are controlled by a governor, a deputy, and 16 directors. In 1694, it was founded as a commercial bank by William Paterson with a capital of £1.2 million, by which was advanced to the government in return for banking privileges, thus it includes the right to issue notes up to the amount of its capital.   Monetary Policy Monetary stability is one of the Bank of England’s two core purposes. Monetary stability means stable prices-low inflation-and confidence in the currency. Define by the Government’s inflation target, as stable prices which the Bank seeks to meet through the decisions on interest rates taken by the Monetary Policy Committee.  To safeguard the value of the currency in terms of what it will purchase is the principle objective of any central bank. Rising prices-inflation-reduces the value of money. For non-inflationary economic growth, monetary policy is directed to achieving this objective and providing a framework. Mainly through influencing the price of money-the interest, as in most other developed countries, monetary policy operates in the United Kingdom (UK). To meet the Government’s inflation target-currently two (2) percent, in May 1997 the Government gave the bank independence to set monetary policy by deciding the level of interest rates. In itself, low inflation is not an end; it is however an important factor in leading helps to encourage long-term stability in the economy. For achieving a wider economic goal of sustainable growth and development, price stability is a precondition. To the functioning of the economy, high-inflation can be damaging. To foster sustainable long-term economic growth, low inflation can help. Based on the Consumer prices Index (CPI), the inflation target of two percent is expressed in terms of an annual rate of inflation. The remit is not to achieve the lowest possible inflation rate. By more than one percent, if the target is missed on either side, the governor of the bank must write an open letter to the Chancellor explaining the reasons why inflation has increased or fallen to such an extent and what the bank proposes to do to ensure inflation comes back to the target. It doesn’t mean that a target of two percent that inflation will be held at this rate constantly. Well, that would be neither possible nor desirable. And by large amounts, interest rates would be changing all the time, causing unnecessary uncertainty and volatility in the economy. To keep inflation at two percent, even then it would not be possible in each and every month. The functions of the bank are that the main business of it is to take deposits and to lend. Between the rates they charge for loans they make profits from the interest margin and the rate they pay to the depositors. In addition to that to that it thus operates the payments system and, for this purpose, about half of the deposits in the bank are sight deposits that may be withdrawn without notice when the account holder makes a payment.  Banks therefore need liquid assets, to cope with net withdrawals of deposits. At the central bank, excess reserves are the banks’ own deposits and they are liquid because they may be immediately withdrawn. To hold as a minimum percentage of their own short-term deposit liabilities, they are the excess over required reserves which many central banks oblige their commercial banks. However, to minimize their holdings of currency which sometimes called vault cash or till money, the banks have an incentive, thus excess reserves because these assets do not earn interest. Banks hold various short-term paper such as bank bills, treasury bills and CD’s and longer-term paper such as government bonds, other than that banks naturally prefer interest-earning liquid assets. It is these liquid assets that enable banks to pay their depositors, since they may be easily sold in the money-market or used as collateral security for loans from other institutions. At the extreme, monetary policy is a potent force. To pay for government operations, in countries such as the Russian Republic, Poland or Brazil where the printing presses run full tilt, money supply is expanding rapidly and the currency becomes rapidly worthless compared to goods and services it can buy. A very high level of inflation or hyperinflation is the result. At the other extreme, restrictive monetary policy has shown its effectiveness with considerable force. In any event, insights into monetary policy are very important to the investor. The availability of money and credit are key considerations in the pricing of an investment.   Central Bank Money: Demand and Supply Because they are the sole issuers of central bank money, central banks can implement monetary policy. A banknote is the most familiar form of central bank money. To issue banknotes in England and Wales, only the Bank of England is allowed. But Bank of England notes are simply supplied on demand. Held by in particular commercial banks at the central bank, the second form of central bank money consists of balances (current accounts or deposits). To the implementation of monetary policy and to the liquidity of the banking system, these balances are crucial both. The terms on which banks and building societies can manage their accounts at the Bank, the central elements in the Bank’s reform of monetary policy implementation concerns. In the form of deposits, commercial banks and in the United Kingdom, building societies are themselves issuers of money. The sole issuer of sterling central bank money is the bank. Banknotes and balances on the reserves accounts of banks and building societies. By setting an interest rate, the quantity of central bank money and equivalently the size and composition of the Bank’s sterling liabilities, is largely demand-determined, which had given that the bank implements monetary policy. It is important that the Bank provides sterling financing in a transparent and non-discretionary way, because the Bank’s Monetary Policy Committee decides the official Bank Rate. Detailed description of the framework   Eligibility to participate in the Bank’s facilities we have criteria for each: reserves scheme membership; access to the standing facilities; and being counterparty in open market operations.  The reserves scheme which they hold reserves on their Real-Time-Gross-Settlement Accounts and Sterling Ordinary Accounts respectively. Standing facilities which they enable participants in the reserves scheme to meet their reserves targets, the Bank requires reserves scheme members to have access to the standing overnight deposit and lending facilities. To have access to the standing facilities, all other banks and building societies that are required to place CRDs at the Bank are also eligible. The Bank believes that all such eligible banks and building societies should sign up to have access to them. Lastly, in open market operations, the bank accepts as counterparties in its open market operations (OMOs): banks and building societies eligible to participate in the reserves scheme; and other banks, building societies and securities dealers authorized under the Financial Services and Markets Act 2000 that are active intermediaries in the sterling markets, subject to standards of prudence and risk. Transactions with the central bank In this analysis, the transactions that are of most interest are those that cause banks to be more or less indebted to the central bank. By drawing a cheque against his bank deposit, consider a payment of tax, and suppose the individual paying the tax does so. To the government the cheque is passed and it is paid into the government’s account at the central bank. This means the paying bank now owes the amount of the cheque to the central bank. When the government spends, the opposite changes take place. At the central bank, suppose the government draws a cheque against its deposit. Thus it presents the cheque to some individual or firm. This causes the bank’s debt to the central bank to be reduced, when the cheque is deposited into a commercial bank account. The commercial banks generally find that collectively they are in debt to the central bank, as a result of all these transactions involving the central bank. This may be caused by net flows into the government’s accounts at the central bank, greater currency demand, bills maturing in the hands of the central bank, maturing central bank loans to the banks, or changes in the other entries on the central bank’s balance sheet. Money-market shortage is which the net amount of indebtedness of banks to the central bank on any day. To the central bank would be for them to draw on their excess reserve deposits, the simple way for banks to pay their debts.       Bibliography: See J. H. Clapham, The Bank of England: A History (2 vol., 1944; repr. 1966); J. Giuseppi, The Bank of England (1966).     Credit:ivythesis.typepad.com

With reference to the Bank of England, explain how monetary policy is implemented

INTRODUCTION First before we tackled on the monetary policy let us view first the background on the Bank of England and ...

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