Financial literacy/ For teachers/ Exercises on monetary policy

Exercises on monetary policy

For teachers

Excercises on Bank of Finland and Eurosystem
Exercises on monetary policy
Exercises on money
Exercises on payments and agreements
Exercises on statistics

For teachers

Excercises on Bank of Finland and Eurosystem
Exercises on monetary policy
Exercises on money
Exercises on payments and agreements
Exercises on statistics

Test your knowledge on monetary policy and price stability and see if you could make it as a central bank Governor.

Assignment 1/4:

The Governing Council of the ECB decides on interest rates

Finland is part of the euro area. Responsibility for the conduct of the single monetary policy in the euro area lies with the Eurosystem. It is composed of the national central banks (NCBs) in the euro area and the European Central Bank (ECB).

Key monetary policy instruments include the policy rates (ECB: also referred to as the key ECB interest rates), on which the Governing Council of the ECB decides in the euro area. In support of its decision-making, the Governing Council of the ECB assesses the nature of the risks to euro area price stability. The Governing Council may decide to raise or lower the key ECB interest rates or keep them unchanged.

[Missing text '/economyassignmentblock/question' for 'English']: 1/12

It is the first Thursday of September. Mario Draghi, the President of the European Central Bank, opens the front door of the European Central Bank in Frankfurt and greets the doorman. This is one of those days when an important meeting will again be held. In addition to Draghi, this meeting will also be attended by the other members of the Executive Board of the ECB and the governors of the central banks of the countries that have adopted the euro. What is this meeting?

A meeting of G20 countries. A meeting of the Governing Council of the ECB. An annual meeting of the World Bank. An ECOFIN Council meeting.

[Missing text '/economyassignmentblock/question' for 'English']: 2/12

The same group of central bankers assembles for these meetings in Frankfurt twice a month. What do they decide at their meetings among other things?

Euro area interest rates. The common euro area budget. Enlargement of the European Union.

The Governing Council of the ECB has no power of decision, for example, in respect of matters related to EU enlargement or the euro area budget.

[Missing text '/economyassignmentblock/question' for 'English']: 3/12

The whole group is now seated at the round table, and the meeting can begin. The President of the ECB chairs the meeting. Who of the following are also present?

Governor of the Bank of Finland. Governor of the Bank of England. President of the Deutsche Bundesbank. Governor of the Bank of Japan.

Only the governors of the euro area central banks take part in decisions in the Governing Council of the ECB on matters concerning the euro area.

[Missing text '/economyassignmentblock/question' for 'English']: 4/12

This time, the meeting is a ‘rate-setting meeting’. Accordingly, the meeting discusses what should be done with the policy rate (ie the key ECB interest rate). Some argue for keeping it unchanged, others would like to lower it. If no unanimity can be reached and it is necessary to vote on the issue, who of the members of the Governing Council has the greatest power of decision at the meeting?

The President of the ECB has two votes, and all the other members of the Governing Council have one vote each. The governors of the central banks of the largest euro area countries, such as Germany and Spain, have more votes and thus more influence on the decisions than the central bank governors of smaller countries, such as Finland, Estonia and Malta. Each member of the Governing Council of the ECB has one vote, in other words, an equal opportunity to influence the decisions.

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What are the options available for an interest-rate decision at the meeting?

The policy rate may be raised. The policy rate may be lowered. It may be decided to keep the policy rate unchanged.

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Do you happen to remember what monetary policy means?

Monetary policy means government decisions on, for example, the level of taxation. Monetary policy is deciding on income transfers, such as pensions and child benefits. Central banks decide on monetary policy. Key monetary policy instruments include the policy rates.

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Does fiscal policy mean the same as monetary policy?

Yes. Monetary policy is the synonym of fiscal policy. No. Fiscal policy is the responsibility of governments, while central banks are responsible for monetary policy.

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When the Governing Council of the ECB decides on monetary policy, what type of analysis does it conduct in support of its decision?

There is no need to conduct accurate analyses. In support of the decision, the risks to price stability have been analysed very closely. For making the decision, the President of the ECB has attended meetings in Brussels with the presidents and prime ministers of various European countries and enquired for their opinion on the stance of monetary policy they would consider the best for the euro area economy.

The Members of the Governing Council of the ECB are not allowed to take instructions from other institutions or bodies, such as political decision-makers.

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What are the criteria on which the Governing Council of the ECB makes monetary policy decisions at its meetings?

Each member of the Governing Council looks after the interests of his own country. The Governing Council assesses the euro area situation as a whole. In the first place, each member of the Governing Council evaluates the situation from the perspective of his own country, but if the interests of the euro area as a whole do not strongly conflict with those of their own countries, the members may also promote the interests of the euro area.

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This Thursday, as always after the ‘rate-setting meeting’ of the Governing Council of the ECB, ECB President Draghi also will host a press conference for journalists at the European Central Bank. At the press conference, the President of the ECB will announce a reduction of 0.5 percentage point in the policy rate (ie the key ECB interest rate). Can you tell what effects this reduction may have on people's lives in Finland?

Interest rates on housing loans may fall; so, mortgage debtors will have more money for other purposes. The central bank's interest rate reduction has nothing to do with Finnish people's everyday life. The Finns must pay more taxes.

[Missing text '/economyassignmentblock/question' for 'English']: 11/12

Which of the following sentences you are sure not to hear from ECB President Draghi at the press conference?

We lowered the policy rates because the President of France urged us to do so. The policy rates were kept unchanged, as inflation expectations for the euro area remain firmly anchored in line with our objective. We decided to raise the policy rate, because inflation appears to accelerate.

The primary objective of the ECB's monetary policy is to maintain price stability. The Members of the Governing Council of the ECB are not allowed to take instructions from other institutions or bodies, such as political decision-makers.

[Missing text '/economyassignmentblock/question' for 'English']: 12/12

Friday-morning newspapers all over Europe write about the decisions made by the Governing Council of the ECB on the previous day. What are the words used by the newspapers in describing the 0.5 percentage point cut in the policy rate?

The central bank tightens monetary policy. Yesterday's central bank meeting chose to ease monetary policy. The central bank again raised interest rates.

Monetary policy tightening refers to raising the policy rate.

You answered correctly:

NB! You can check the correct answers for each question

Assignment 2/4:

Prices under control

The main objective of the ECB's monetary policy is to maintain price stability in the euro area, thereby safeguarding the purchasing power of the euro. Price stability refers to conditions where there are no real signs of inflation or deflation, where prices do not fall or rise significantly but remain stable. Price stability is defined as a year-to-year increase in consumer prices of below 2%, and price stability is to be maintained over the medium term.

Inflation is harmful in many ways. It undermines economic decisions and leads to slower economic growth. In addition, inflation is unfair, since it eats up the value of savings and weakens the position of small savers in particular. Deflation is even more harmful than inflation. It results in a downward spiral of prices and wages while the value of money goes up. During periods of deflation, repayment of loans must be made with money that is worth more than when the loan was taken, and hence deflation has often given rise to debt crises and a growth in bankruptcies.

[Missing text '/economyassignmentblock/question' for 'English']: 1/9

Minna works as an economist at the Bank of Finland and is tasked with monitoring the euro area economy and especially euro area price developments. How are price developments monitored?

Using the consumer price index, the value of which is determined once a month on the basis of the prices of goods chosen for the ‘shopping basket’. Once a month, a Gallup poll is organised, where people are asked about their perceptions of price changes in the last 12 months. Changes in coffee cup prices are a relevant indication of a change in the overall price level.

[Missing text '/economyassignmentblock/question' for 'English']: 2/9

Minna is responsible for reporting to the Governor of the Bank of Finland on inflation developments in coming years. The latest euro area data point to an inflation rate of 1.9%. All suggests that average inflation will also remain just under 2% in the next few years. What does Minna tell the Governor?

‘It now seriously looks like inflation is running out of control.’ ”Tämänhetkisten tietojen valossa inflaatiotavoitteessa pysytään.” ”Deflaatio näyttää kolkuttelevan ihan nurkan takana.”

An inflation rate of 1.9% is in line with the ECB's objective of price stability. Deflation refers to a fall in prices. This does not seem likely according to what is explained in the text related to the question.

[Missing text '/economyassignmentblock/question' for 'English']: 3/9

Minna also maintains a popular blog ‘Give the inflation bugbear a beating’, where she reports the current interesting news on the economy. This morning Minna updated her blog with the latest inflation data. Konsta, who had just received his driving licence, already gave feedback to Minna, noting that he had difficulties in believing in moderate inflation, because fuel is getting more expensive all the time. What does Minna answer?

Changes in the prices of individual products must be kept separate from changes in the general price level. Individual changes do not yet point to changes in the general price level. When I wrote that inflation is 1.9%, it also means that the price of fuel has risen by 1.9% on the previous year. The fuel price has nothing to do with inflation. Inflation only illustrates changes in the price of food.

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During the day, Minna's blog also becomes an arena for discussion on deflation. Minna has written that deflation may be even more dangerous than inflation. Maarit does not understand what deflation means. What does Minna answer?

Deflation means a rise in prices. Deflation means a slowing in price increases. Deflation means a fall in prices.

[Missing text '/economyassignmentblock/question' for 'English']: 5/9

Minna is satisfied that so many of the blog readers appear to be interested in inflation, because the primary objective of the ECB's monetary policy is precisely to maintain price stability in the euro area. Minna still asks whether everybody knows which of the following inflation figures is closest to the ECB's objective of price stability?

1,9 % 0 % –2,0 %

The Governing Council of the ECB seeks to maintain the inflation rate below, but close to, 2% over the medium term, which is about 2–5 years. If the objective were 0%, there would be a threat of deflation.

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Do you know yourself what this inflation objective is aimed at, among other things?

To prevent disadvantages from deflation. To ensure that prices always remain at the same level. To ensure that all prices decline month by month.

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Can you tell what is more important than the objective of price stability when the Governing Council of the ECB makes its interest rate decision?

A threat of increasing unemployment. A threat that economic growth will be contracting strongly. If unemployment threatens to increase, although the economy is growing. None of the above.

[Missing text '/economyassignmentblock/question' for 'English']: 8/9

Minna's weekly question to the blog readers is what will happen to prices if inflation slows from 3% to 1%. What is the answer to the week's question?

The rise in prices will slow. Prices will fall. The pace of increase in prices will accelerate.

[Missing text '/economyassignmentblock/question' for 'English']: 9/9

There will be a draw from among those who have given the right answer to determine who will receive the prize, an MP3 player. In updating data on the prize in the blog, Minna makes a typing error and accidentally writes EUR 10,000 as the value of the player worth EUR 100. Whoops, now hyperinflation seems to be hitting, is Konsta's immediate response to the blog message. How is hyperinflation often defined?

Monthly inflation is over 50%. Prices fall by more than 20% a month. Prises rise by about 2% a year. Annual inflation is 10%.

You answered correctly:

NB! You can check the correct answers for each question

Assignment 3/4:

Test whether you would make a good central bank governor!

Use this test to determine whether you would make a good central bank governor! Think about the interest rate decision from the viewpoint of the European Central Bank. You are expected to make the right interest rate decision when you know the changes in inflation and the expectations regarding future inflation, the changes in the money stock, economic growth and unemployment. You have to choose whether to lower or raise the policy rate or keep it unchanged. Good luck in your decision-making!

Lowering the interest rate increases consumption and borrowing opportunities, and thus accelerates inflation. Raising the interest rate, in turn, reins in consumption and borrowing opportunities, and thus slows inflation.

In making the decision, keep in mind that the primary objective of the ECB's monetary policy is to maintain price stability in the euro area, thereby safeguarding the purchasing power of the euro. Price stability is defined as a year-to-year increase in consumer prices of below 2%, and price stability is to be maintained over the medium term.