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THE QUALITY OF MONEY and A COMPARISON OF THE ECB AND FED`S BALANCE SHEET POLICIES Philipp Bagus

THE QUALITY OF MONEY and A COMPARISON OF THE ECB AND FED`S BALANCE SHEET POLICIES Philipp Bagus. INDEX. The quality of money. The balance sheet of a central bank. The balance sheet policies of the ECB and FED. An interpretation of the results. Exit strategies. Conclusions.

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THE QUALITY OF MONEY and A COMPARISON OF THE ECB AND FED`S BALANCE SHEET POLICIES Philipp Bagus

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  1. THE QUALITY OF MONEY and A COMPARISON OF THE ECB AND FED`S BALANCE SHEET POLICIES Philipp Bagus

  2. INDEX • The quality of money • The balance sheet of a central bank • The balance sheet policies of the ECB and FED • An interpretation of the results • Exit strategies • Conclusions

  3. I. THE QUALITY OF MONEY Quality of money (subjective concept): The capacity of money as perceived by actors, to fulfill its main functions Influences the demand for money and its purchasing power Neglected Single-sided focus on the quantity of money

  4. I. THE QUALITY OF MONEY Quantity is the only thing that matters Math, measurement Modern neglect EQ analysis Best money found

  5. I. THE QUALITY OF MONEY Quantity theory cannot explain: Origin of money Demonetization

  6. I. THE QUALITY OF MONEY Quantity of money affects: Marginal Utility .... 1657th unit of money 2nd bottle of water 1658th unit of money 1st chewing gum 1659th unit of money

  7. I. THE QUALITY OF MONEY Qualitity of money affects: Marginal Utility .... .... 1st chewing gum 1657th unit of money 3rd bottle of water 2nd bottle of water 1657th unit of money 1658th unit of money 1st pencil 1st chewing gum Qualitity of money decreases: 1658th unit of money

  8. I. THE QUALITY OF MONEY Higher demand Higher quality of money “prices” fall Higher purchasing power Six individual determinants of prices: • Number of goods offered/demanded • Intensity buyer/seller of goods • Intensity buyer/seller of money

  9. I. THE QUALITY OF MONEY Six individual determinants of prices: The higher buyer/seller value money in relation to other goods, the higher the purchasing power of money Changes may be abrupt Prices may change without changes in quantity

  10. I. THE QUALITY OF MONEY Non-monetary demand (insurance) Quality of money as a medium of exchange What makes a good medium of exchange? Users (legal tender) „Costs of usage“

  11. I. THE QUALITY OF MONEY “Cost of usage” Recognizability Transportation Storage Durability Homogeneity Divisibility

  12. I. THE QUALITY OF MONEY Non-monetary demand (insurance) Quality of money as a medium of exchange Users (legal tender) „Costs of usage“ Improvements Quality of money increases Prices

  13. I. THE QUALITY OF MONEY Store of wealth function Money most liquid good (bid-ask spread) Cash balance insurance Exchange takes place in time

  14. I. THE QUALITY OF MONEY What makes a good store of value? Quality of money as Hoardability Competition a store of value Possibility to increase Monopoly Independent? Statutes? Staff? Mandate?

  15. I. THE QUALITY OF MONEY What makes a good store of value? Quality of money as State of government a store of value Liquidity of banking system Bailout?

  16. I. THE QUALITY OF MONEY What makes a good store of value? Quality of money as Coin clipping Integrity Redemption rate a store of value Good or rights of different quality Backing Convertibility Assets of central bank

  17. II. THE QUALITY OF MONEY AND THE BALANCE SHEET OF CENTRAL BANKS “Objective” Quality of Money and CBs Assets backing monetary base Monetary base

  18. II. THE QUALITY OF MONEY AND THE BALANCE SHEET OF CENTRAL BANKS Assets Liabilities Government bonds Gold Foreign reserves Loans to the banking system Equity Currency Bank reserves

  19. II. THE QUALITY OF MONEY AND THE BALANCE SHEET OF CENTRAL BANKS Assets “back” liabilities” Defend currency externally and internally “de facto” redemptions Support of banking system Monetary reform Collapse “left over”

  20. II. THE QUALITY OF MONEY AND THE BALANCE SHEET OF CENTRAL BANKS Quantitative easing: CB´s balance sheet expansion Qualitative easing: Reduction of average quality of assets backing liabilities • Change in balance sheet size • Asset swap Possibility: Quantity of money constant but quality of assets deteriorate

  21. II. COMPARISON ECB and FED FED has received attention (change in composition and expansion) ECB also changed its balance sheet policies Comparison and Implications

  22. Eurosystem in million €

  23. FED in million $

  24. FED in %

  25. ECB in %

  26. ECB lending operations %

  27. II. COMPARISON ECB AND FED How did better? Regulatory changes In first sight: ECB ECB laxer rules before crisis (ABS with A-) collateral vs FED (AAA) Both increased terms (ECB 1 year, FED 3 months)

  28. II. COMPARISON ECB AND FED How did better? Regulatory changes Collateral (Both extended range, ECB in Oct. 2008 BBB-) Counterparties (Both extended range, new facilites and swaps) Transparency (FED more transparent with new facilities)

  29. Comparison of balance sheet ratios

  30. VI COMPARISON FED AND ECB Qualitites of currencies Both deteriorated balance sheets FED started from better position, deteriorated more until Lehman FED new facilities vs. ECB existing ones Non-measurable effects more important for ECB Recapitalization problem for ECB Exchange rate

  31. Thank you very much ! Questions?

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