Question

Question one

For this question, refer to the Bank of Ghana’s Monetary Policy Committee Press Release of March 18, 2020.

a) In ordinary language, explain the meaning of monetary policy. What is the difference between monetary policy and fiscal policy?

b) Explain the difference between monetary loosening and monetary tightening.

c) According to the statement, the MPC reduced the monetary policy rate by 150 basis points. Does this constitute a monetary loosening or monetary tightening? Explain

d) When deciding whether to tighten or loosen monetary policy, central banks weigh the relative risks to price stability and growth. Mention two indicators that the MPC use to gauge the risk to inflation and two indicators the MPC use to gauge the risk to growth.

e) Based on the information in the Press Release, in the thinking of the MPC did the risk to growth outweighed the risk to inflation or vice versa? Refer to specific points from the press release to back up your argument.

f) Using the money market diagram, explain the effect of this policy measure on the real interest rate and real money holdings.

  

g) In ordinary language, explain how the reduction in the Monetary Policy Rate will help the relative risk identified in part (e) above.

h) In addition to the reduction in MPR, the MPC also reduced the Primary reserve requirement from 10% to 8%. Explain how this additional measure will affect the economy, carefully explain the channel.

Problem two

All else being equal, how would each of the following affect the demand for M1(Narrow money)? The demand for M2 (broad money)? Explain.

a) Home equity lines of credit that allow homeowners to write checks against the value of their homes are introduced.

b) The stock market crashes, and further sharp declines in the market are widely feared.

c) Banks introduce overdraft protection, under which funds are automatically transferred from savings to checking as needed to cover checks.

d) A crackdown reduces the illegal drug trade (which is carried out largely in currency).

Problem three

For this problem, refer to the article from the Economist Intelligence Unit titled “Currency rally likely to prove short-lived”, that is attached to the questions.

a) The article attributes the fall in the Ghanaian cedi since the 2012 to negative domestic and external factors. The main negative external factor has been the decline in the prices of Ghana’s primary commodity exports (cocoa, gold and oil). With the aid of a diagram, explain how the falling commodity prices can lead to a depreciation of the Ghanaian cedi.

b) The article also mentions weak domestic economic management as another cause of the Cedi’s depreciation since 2012:

“Both the fiscal and the current-account deficits were above 10% of GDP in 2012‐13, and it was concerns about the government's financial management, coupled with economic imbalances, that tipped sentiment against the cedi. As the government tried with little success to stabilize the economy, market sentiment soured further”.

With the aid of a diagram, explain how weak management of the domestic economy can lead to a depreciation of the Ghanaian cedi.

c) The article identifies the factors that led to the appreciation of the currency in July 2015:

“In July the IMF conducted its first review of the programme and praised the government's strong record on meeting revenue and expenditure targets and its progress on reforms including cleaning up Ghana's bloated public payroll and liberalising petroleum pricing to reduce budget subsidies. Around the same time the Bank of Ghana (the central bank) disclosed its intentions to sell more dollars to the market and forecast fresh foreign-exchange inflows in the second half of the year from a planned Eurobond and an annual cocoa sector loan. These events caused a rapid rebound in the currency, which strengthened significantly, slashing its 2015 losses to 7.6%”.

Using your diagram from part (b), explain how the Eurobond and an annual cocoa sector loan can lead to an appreciation of the Ghanaian cedi in July 2015.

d) The author of the article believes that the long-term solution to the instability of the Ghanaian cedi is a structural shift of the economy from reliance on primary commodities to “agro-based manufacturing into multiple value-added export products”. Explain how this structural shift can bring about stability in the value of the currency.

Problem four

The table below contains information extracted from the 6th round of the Ghana Living Standards Survey (GLSS) conducted from September 2012 to September 2013.

Total number of people (15 years and above)

45,697

Q1: Did you do any work for pay, profit, family gain or did you produce anything for barter or home use during the last 7 days even if it was for only one hour?

Yes No

29,461 11,836

Q2: In the last 7 days were you an apprentice?1 Yes

No

496 10,340

Q3: Were you temporarily absent from work in the last 7 days or did you have a job, business, or other economic or farming activity that he/she will definitely return to?2

Yes No

1,394 7,954

1 This was asked only for those who answered “No” to Q1

2 This was asked only for those who answered “No” to Q1 & Q2

Q4: Were you available for work during the last 7 days or within the next 4 weeks if there had been an opportunity to work?3

Yes, last 7 days

Yes, but only within the next 4 weeks No

1,301 160 6,318

Q5: Did you make any effort during the last 7 days or past 4 weeks to find work or start own business?4

Yes, last 7 days

Yes, prior to last 7 days but in the last 4 weeks

No

419 198 4581

Note: The questions have been slightly altered from the original question form in the GLSS without any material change in the import of the original question.

a) Calculatethenumberofpeoplewhowereemployed(includingthosein apprenticeship)

b) Calculate the number of people who were unemployed

c) Calculatethenumberofpeopleinthelabourforce

d) Calculate the labour force participation rate

e) Calculatetheunemploymentrate.

f) How many discouraged workers are in the economy?

Problem five

a) Explain the concept of inflation in ordinary language. How is inflation measured? Provide a formula.

b) Differentiate between disinflation and deflation.

c) Differentiate between core and headline inflation. Which one is the preferred measure of inflation by central bankers and why?

For the rest of this question, refer to Table 1 below Table 1. Chain-linked CPI series

3 This was asked only for those who answered “No” to Q1, Q2 & Q3 4 This was asked only for those who answered “Yes” to Q4

Month

CPI

Month

CPI

Month

CPI

Oct-17

96.503

Aug-18

102.891

Jun-19

109.967

Nov-17

97.384

Sep-18

102.988

Jul-19

110.352

Dec-17

98.376

Oct-18

103.269

Aug-19

110.808

  

Jan-18

99.766

Nov-18

103.532

Sep-19

110.774

Feb-18

100.000

Dec-18

104.079

Oct-19

111.235

Mar-18

100.394

Jan-19

105.631

Nov-19

111.978

Apr-18

101.081

Feb-19

106.094

Dec-19

112.303

May-18

101.647

Mar-19

106.948

Jan-20

113.896

Jun-18

102.293

Apr-19

107.606

Feb-20

114.360

Jul-18

102.662

May-19

108.780

Mar-20

115.310

Source: Ghana Statistical Service

d) What is the base month for the CPI series? What does a CPI below 100 imply?

e) Calculate the inflation rate for March 2020.

f) How much goods and services will GHC2000 in January 2020 buy in October 2017.

g) Suppose in March 2018 you gave your friend a loan of GHC3,000 to be paid at the end of March 2019. What interest rate should you charge so that the total amount your friend pays back equals exactly the GHC3000 you lent him/her in real terms? Imagine that your friend does not understand the concept of interest rate and simply wants to know how much he should pay you back in total. How much will it be?

Answer 1

Q1) a) So, in simple terms, monetary policy refers to the policies which are adopted by the monetary authority of a country, like the Central Bank in the US, to control the money supply in the economy, in order to achieve certain economic goals. These goals vary from controlling inflation to targetting the interest rate to ensuring the presence of price stability and confidence in the domestic currency etc. The difference between monetary and fiscal poicy lies in way the instruments are used. Though, both of these have a common goal of reducing fluctuations in the economy and smoothening out the economic cycle, the ways in which they do so differs. Monetary policy makes the use of money supply and interest rate to impact the aggregate demand in the economy whereas fiscal policies are operated vvia government spending and levels of taxation to influence the aggregate demand in the economy.

b) Now, a monetary policy which reduces the interest/Fed funds rate, in order to facilitate borrowing, or increase money supply in the economy is known as monetary loosening or expansionary monetary policy. The opposite scenario of raising interest rates, which will constrict borrowing and money supply in the economy is known as monetary tightening or contractionary monetary policy. A tight monetary policy is used to reduce the aggregate demand in the economy, which will consequently lower inflation, real output and increase unemployment. A loose monetary policy, on the other hand, increases aggregate demand in the economy, which will consequently increase the inflation, real output and reduce unemployment. Loose policy 'heats' up the economy while tight policy 'cools' it down.

c) One basis point is equal to 1/100th of a percent or 0.01%. So, reducing the interest rate by 150 basis points implies the rate is reduced by 1.5%. So, as mentioned above, reducing the interest rate refers to a monetary loosening or expansionary policy. A cut in the interest rate makes borrowing much more cheaper for consumers. They can make more purchases on credit such as home mortgages, auto loans, credit card bills etc. Now, how does the Fed do it? There is a target Fed Fund's rate which is set by the central bank at which the commercial banks borrow and lend out their excess reserves in the overnight market. Now, the Fed changes this Fed's Funds rate to influence the money supply, by directly affecting banks and indirectly affecting consumers. When the Fed lowers the interest rates, these lower financing costs help to facilitate borrowing and investing. This helps the consumers save up money by lowering the interest rates and thus, increasing their purchase power. This increases aggregate demand in the economy which help to reduce unemployment in the economy.

d) An economic indicator is a statistic regarding an economic activity. It is used to assess, measure and evaluate the state of the economy. When the MPC wants to gauge if there is any risk related to inflation, there are certain key indicators. Two such indicators used are CPI and PPI. CPI or Consumer Price Index is used to calculate the inflation rate by measuring the price changes in the basket of consumer goods and services. It helps MPC to gain a clear insight into future inflation and oncoming risks. PPI or Producer Price Index is a weighted index to measure shifts in price of goods and services from a producer's perspective. This is also a key indicator of inflation and associated risks. Now, when it comes to economic growth, the most accurate indicator used is GDP or Gross Domestic Product. It measures the level of national income, spending and output in the economy. It can be measured in per capital/per head terms. Other indicators are strong employment numbers and desired stable inflation rates. All of this indicates that the economy is on track for economic growth.

As per rules, have answered the first four subparts of the first question. Thank you.