English for Economists

mercial banks realize that they have more reserves than they need for prudent operation. Therefore, they extend their lending to households and firms by lowering their interest rates. In contrast, when the central bank sells treasury bills or government bonds, the commercial bank will make the payment for the securities from the reserves it deposited at the commercial bank. After the transaction has been completed, the level of reserves will be lower than before, and hence the commercial banks will raise their interest rate to cut their credit to households and firms. In both cases, the change in the reserves translates into a change in the credit provided to firms and households.

Finally, the central bank also requires the commercial banks to hold a percentage of their deposits as reserves. These are called required reserves, and the percentage is known as the required reserve ratio. These reserves are meant to ensure some minimum level of prudence, even if not all commercial banks want to operate as prudently as they should. If the central bank increases the reserve ratio, then the actual reserves of the banks will fall short of the required ratio. Thus the banks will have to raise their interest rate to cut back on loans, and deposit the money freed up as reserves at the central bank. The opposite happens if the central bank decreases the required reserve ratio. Suddenly banks have more reserves than they want to hold, so they will lend the money instead of holding it at the central bank. So if the required reserve ratio increases, the commercial banks lending to households and firms falls. The opposite happens when the required reserve ratio decreases. It is important to point out that required reserve ratios are very stable – central banks do not like to change them too often.

Our discussion indicates that the level of cash deposits and commercial banks' reserves held at the central bank plays an important role in transmitting the central bank's monetary policy to the banking sector and the financial markets. The cash in circulation and the reserves of private banks together are called the monetary base. As we have already said, the central bank has a monopoly over money creation, more precisely, over monetary base creation. The power of a central bank rests on its ability to control the monetary base.

You may wonder, however, why the monopoly to create the monetary base makes the Bank of England or other central banks so important for the economy? After all, financial markets had become very complex and large by the beginning of the twenty-first century. If most transactions are carried out with credit cards, cheques and bank transfers, why would the ability to create cash or reserves matter?

First, we should recall that cash is still used in a large number of transactions. Although its scope and use have diminished over the last 30 years, it does not seem that cash is going to disappear in the near future. Second, even

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if a transaction does not involve the use of cash or reserves directly, it typically requires that someone somewhere holds a monetary base. For example, paying by cheque assumes a bank account with deposits, and the bank is required to hold a fraction of these deposits as reserves. Similarly, credit card bills must also be settled using cash or bank deposits. In the latter case, the bank has to hold the corresponding required reserves. In some sense, we can say that the whole financial system rests on the monetary base – and this makes the central bank a powerful institution.

The amount by which a change in the monetary base is multiplied to determine the resulting change in the money supply is called the money multiplier.

TRANSLATION

A. Translate into Russian with a dictionary.

Monetary Policy during the Great Depression

Monetarists and Keynesians still debate the causes of the Great Depression. Monetarists Milton Friedman and Anna Schwartz, in their book A Monetary History of the United States, argued that the Great Depression was caused by the decline in the money supply, the changes in the price level, real GDP, and unemployment rate.

During the 1920s, the money supply expanded steadily, and prices were generally stable. In response to the great stock market crash of 1929, bank failures, falling real GDP, and rising unemployment, the Fed changed its monetary policy. Through the Great Depression years from 1929 to 1933, M1 declined by 27 percent. Assuming velocity is relatively constant, how will a sharp reduction in the quantity of money in circulation affect the economy? Monetarists predict a reduction in prices, output, and employment. The price level declined by 24 percent between 1929 and 1933. In addition to deflation, real GDP was 30 percent lower in 1933 than in 1929. Unemployment rose from 3.2 percent in 1929 to 24.9 percent in 1933.

Friedman and Schwartz argued that the ineptness of the Fed's monetary policy during the Great Depression caused the trough in the business cycle to be more severe and sustained. As proof, let's look at the period after 1933. The money supply grew and was followed closely by an increase in prices, real GDP, and employment.

The Great Depression was indeed not the Fed's finest hour. In the initial phase of the contraction, foreign banks were fearful and withdrew large amounts of their gold from U.S. banks. To stop the outflow of gold to other

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countries, the Fed raised the discount rate in 1931. As a result, banks borrowed less of their required reserves from the Fed's discount window, and the money supply fell. Later the discount rate fell, but only after the economy was deeper into the Great Depression.

What should the Fed have done? Friedman and Schwartz argued that the Fed should not have waited until 1931 to use open market operations to increase the money supply. Thus, they concluded that the Fed was to blame for not pursuing an expansionary policy, which would have reduced the severity and duration of the contraction.

Finally, although the emphasis here is monetary policy, it should be noted that both monetary and fiscal policies worsened the situation. President Hoover was attempting to balance the budget, rather than using expansionary fiscal policy.

Note:

1. ineptness n – неуместность.

B. Translate into English with a dictionary.

Сущность денег полнее всего проявляется в их функциях. Деньги выполняют следующие функции: мера стоимости, средство обращения, средство накопления и образования сокровищ, средство платежа, мировые деньги. Первой является функция меры стоимости. Именно в деньгах определяется стоимость любого товара (определяется его цена). Стоит заметить, что золото выполняет данную функцию идеально. Функция денег как средства обращения обуславливает нормальное протекание обмена товарами. Деньги становятся посредником в любом акте товарного обмена, делая этот процесс менее сложным для товаропроизводителей. Функция денег как средства накопления также представляется достаточно очевидной. Накопление денег в виде золота - это фактически накопление стоимости в наиболее ликвидной форме. Интересной является функция денег как средства платежа. Здесь важным представляется то, что процесс продажи и оплаты товара разрывается во времени. Между актом купли товара и его оплатой проходит некоторое время. Очевидно, что такая отсрочка может иметь место только в том случае, если продающий данный товар получит от покупающего его гарантии оплаты в определенное время. И, наконец, функция мировых денег. Здесь мы фактически утверждаем, что товарденьги – это всеобщий эквивалент, который выходит за национальные границы, превращаясь в общемировое явление, выступая в международном товарном обмене и мерой стоимости, и средством обращения, и средством платежа.

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bank run. [...]

The fourth main task of the central bank would be to

(4)………………………, in case, actually, one of these commercial banks goes bankrupt and the investors, the people putting money in the bank, have to get back their money.

B.Read the six sentences below, which also summarize central banking functions, but slightly differently, and match them up with the six expressions you have written in A.

a)controlling the amount of banknotes in circulation;

b)establishing maximum and minimum lending rates, thereby controlling the credit system;

c)ensuring that banks have a sufficient liquidity ratio to allow customers to withdraw their deposits when they want ;

d)intervening on foreign exchange markets, buying or selling large amounts of the national currency, to prevent major fluctuations;

e)lending money to a commercial bank in danger of going bankrupt;

f)selling government bonds to commercial banks or buying them back, in order to alter the amount of credit the banks can offer (and thereby alter the money supply).

C.Listen to Part Two of the interview and answer the following question:

What is Gabriel Manganos opinion concerning central bank independence, and why?

Look through the following statements. Listen to the extract again, and decide whether the statements are TRUE or FALSE. Correct them if they are false.

1.Gabriel Mangano says that governments tend to increase the money supply in the months before an election, which helps reduce unemployment.

2.Mangano states that the central bank should be the branch of the government that implements monetary policy.

3.Mangano considers that the central bank should be the branch of the government that implements budgetary policy.

4.Mangano suggests that governments always have a budget deficit.

5.Mangano points out that the US Federal Reserve is not concerned with price stability.

6.Mangano is of the opinion that there should be a limit to the central bank's independence.

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SPEAKING

A.

While reading the conversation of Paul Volcker with the interviewer, jot down the main points. Based on your notes, be ready to perform as Paul Volcker in the class and answer the students’ questions about the monetary policy of the Fed in the1980-ies.

Talking with Paul Volker

Paul Volcker served as chairman of the board of governors of the Federal Reserve System from 1979 to 1987, a time when double-digit inflation was gripping the U.S. economy. Michael Parkin spoke with Mr. Volcker about his experience as chairman of the Fed and about his vision and concerns for the future of the economy.

I.: Mr Volcker, what originally attracted you to economics?

P.V.: I was an undergraduate immediately after the Second World War. I think a lot of people at the time got interested in economics because they hoped of the idea that after the war things must be able to work better than they had during the Depression, and they were filled with a zeal for doing better. That was part of my thinking, but just as important, economics seemed to me, of all the social sciences, to have a little more precision. I thought I could combine this practical, logical structure with an instinct for public service. In retrospect, I'm sure I overestimated the logic and coherence!

I.: What are the economic principles that you, learned in school that have proved useful in your professional life?

P.V.: Some economic principles are eternally useful. Economics does teach you the discipline of understanding that the direct immediate effects of some action may not be the full story — that without close analysis and study you may have unintended and unanticipated effects later on. Those later "side effects" may be greater than the immediate effects. Finally, the concept of looking at the margin — at incremental effects — is very important in terms of actual policy.

I.: Is a background in economics, familiarity with economic principles, mandatory for a chairman of the Federal Reserve?

P.V.: I haven't been able to detect any correlation in performance between chairmen that were economists and those who were not. The chairman doesn't have to be a trained economist if he or she has a

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staff of very good economists. Without that, you'd really be in trouble.

I.: There must be as many opinions about what the Fed should be doing as there are economists. How do these controversies among macroeconomists affect the Fed's job? Are they relevant for the conduct of monetary policy?

P.V.: Oh, I think they're relevant. The internal technical debate doesn't make that much difference. But to the extent that economists' positions on public policy influence public opinion and differ widely, you lack a consensus against which to conduct policy, in a political context, some of these different points of view become politicized. That's part of the environment in which the Fed must operate.

The one advantage when you're the chairman of the federal Reserve Board is that you can sometimes influence — or can lead yourself and everyone else into thinking that you can influence — the nature of the consensus about economic policy, as it is actually reflected in public opinion.

I.: There has certainly not been consensus about the consequences of the Fed's policy in fighting inflation during the late 1970s and early 1980s, while you were chairman. When you embarked on your war against inflation, did you expect to be presiding over the longest peacetime recovery in U.S. history?

P.V.: I thought then, and think now, that inflation is the enemy of sustained expansion. But dealing with these things always turns out to be more difficult, more complicated, and to take longer than you expect. I guess I did misjudge how long we could put up with internal government deficits and external trade imbalances.

I.: What were you missing?

P.V.: In part I think there is a much more fluid international capital market than we had recognized. I would not have guessed that the United States could borrow, or that the Japanese would be willing to lend, so much money year after year without more uncertainty about the dollar. I would not have guessed that the value of the dollar could come down from its high level as much as it has without more disturbance in interest rates and inflation. We've been very fortunate in being able to manage that big a decline in the value of the dollar with as little inflation as we've had.

I.: Did your war on inflation cost more in human terms than you had thought?

P.V.: Stopping inflation is never easy. What I object to is that people said

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that the Federal Reserve caused the recession in the early 1980s and all its pain and suffering. But, in my view, we were going to have the pain anyway. It was just a question of when and how. We thought it would be less if we dealt with the inflation earlier rather than later.

One of my predecessors, Bill Martin, once described the Fed's job as taking away the punch bowl just when the party's getting good. You avoid the hangover that way, or reduce it anyway.

I.: Do you bring the punch bowl back if the party starts to fade?

P.V.: My critique of Federal Reserve history is not that it was always too harsh and brought all these expansions to an end when they could have gone on forever. But sometimes the Fed was overeager to get the party started. Once you get in a recession, the pressures on the Fed are very strong. Even after you come out of the recession, the temptation is to overstimulate. But policy only works with a lag and the lags catch up with you. You're off to another jolly party again. We tried to avoid this last time, I think with some success.

I.: We've talked a bit about the government's budget deficit. Did the government's need to finance its budget deficit affect your job as chairman of the Fed?

P.V.: I do not believe that the Federal Reserve was forced into inflationary financing. In retrospect, the government's budget deficit position did not in fact appear to impair our ability to achieve a record expansion. But if you look at whether the expansion can be carried on for another seven years, you have to get concerned about our relatively low level of investment, our low productivity, and our dependence on foreign lending and investment. None of these can be dealt with by monetary policy alone. Fiscal policy gives you an expansionary thrust, which then has to be countered by tighter monetary policy — by higher interest rates. This leaves you with a vulnerable economy, increasingly dependent on money borrowed from overseas.

I.: Our economic relationship with other countries also includes the exchange of goods and services. In recent years we have been experiencing a substantial decline in net exports. What do you see as the principal cause of the external trade deficit?

P.V.: It's an internal imbalance between our ability to produce and our propensity to spend. Our spending is mostly consumption, personal and public. Investment is, at best just so-so a period of expansion. So a major policy challenge is to find a way of cutting consumption. On the other hand, there are imbalances in the opposite direction in other economies. The Japanese are doing a good job in beginning to deal

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with this problem. But it is true that there is a bias in the trading world toward less openness. If you took a snapshot of the world trading scene, you'd have to agree that the United States is by far the most open market of all, and our trading partners are more closed. How do you deal with that complaint? You can't ignore how these imbalances are aggravated by our own internal economic policies, our own consumption.

I.: What will improve the situation?

P.V.: We've got to contain domestic spending and we've got to see foreign markets open up so that foreign expenditure for our goods increases. Of course, just opening foreign markets wouldn't induce any change in our own spending by itself. Moreover, changing our spending pattern can't be done just by monetary policy, by high interest rates. Monetary policy won't move spending from consumption into investment. That means you've got to bring fiscal policy to bear. More taxes or less spending or both. But now you've got a lot of political choices. You'll have to make some political bargains in order to get expenditure cuts.

I.: When a college student seeks your advice on the choice of a career, what do you suggest?

P.V.: I'd strongly encourage him or her to consider a career in public service. There are so many important jobs for people in the government. Who do we look to for the solution of problems like AIDS? The government. Who's going to solve the drag problem, if anyone can? The government. We need young people who recognize the challenge and excitement and satisfaction of service to the public. Without their contributions, we will have a serious problem in this country.

Ex. 1. Match the words in A with their definitions in B.

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