Interest Rates and Monetary Transmission Study Guide

Vocabulary flashcards covering Central Bank roles, money market equilibrium, tools of monetary control, and the economic transmission mechanism.

Central Bank

An institution designed to oversee the banking system and regulate the quantity of money in the economy.

South African Reserve Bank (SARB)

The central bank of South Africa responsible for functions such as issuing currency, acting as bank of discount and lender of last resort, holding foreign reserves, and conducting monetary policy.

Monetary Policy

The set of actions taken by the central bank in order to affect the money supply.

Reserve Requirements

A monetary tool where the central bank sets a minimum ratio of cash reserves to deposits that commercial banks must hold.

Money Multiplier

The factor by which an initial deposit expands the total money supply through repeated rounds of lending and re-depositing.

Discount Rate

The interest rate the central bank charges when commercial banks borrow from it, known in South Africa as the repo rate.

Open Market Operations (OMOs)

Actions taken by the central bank to alter the monetary base by buying or selling financial securities, typically government bonds, in the open market.

Capital Adequacy Ratio

The required minimum value of a bank's own capital (shareholders' equity) relative to its outstanding loans and investments.

Securitized Products

Bundles of loans repackaged and sold as investments, which played a central role in the 2008/9 global financial crisis.

Real Money Demand Curve ($LL$)

A downward-sloping curve plotting the demand for real money balances against the interest rate, reflecting the opportunity cost of holding money over interest-bearing bonds.

Real Money Supply ($M/P$)

The nominal money supply ($M$) divided by the price level ($P$), represented graphically as a vertical line.

Wealth Identity

The identity $W = L + B$, where total fixed wealth ($W$) is allocated between money holdings ($L$) and bond holdings ($B$).

Monetary Instrument

The economic variable over which the central bank exercises day-to-day direct control, such as a short-term interest rate.

Intermediate Target

A key economic indicator used as an input to frequent decisions about setting the monetary instrument, such as inflation forecasts.

Price Stability

The primary objective of monetary policy in most countries, including South Africa, which focuses on keeping inflation low and predictable.

Transmission Mechanism

The channel through which monetary policy affects economic output ($Y$) and aggregate demand ($AD$) via interest rate impacts on consumption ($C$) and investment ($I$).

Wealth Effect

The shift in the consumption function resulting from changes in household wealth, operating directly through real money supply or indirectly via interest rates and bond prices.

Autonomous Consumption

The portion of household consumption spending that does not depend on current income, influenced by factors such as credit availability.

Permanent Income Hypothesis (PIH)

A theory stating that household consumption reflects long-run permanent income (average expected income over time) rather than current disposable income.

Life-Cycle Hypothesis

A theory postulating that individuals plan lifetime consumption based on lifetime income and wealth, dissaving during youth and old age while saving during middle-age earning years.

Long-Term Interest Rate

An interest rate influencing long-term borrowing that equals the average of expected short-term interest rates over the same period plus a risk allowance.

Investment Schedule ($II$)

A downward-sloping schedule plotting planned investment demand against the interest rate, where higher rates reduce the number of profitable investment projects.