15 Flashcards
What are the two main roles of a central bank?
The Government’s Bank and The Bankers’ Bank.
What are the functions of a central bank as the Government’s Bank?
Manages government finances
Prints currency
Controls money and credit through interest rates
What are the functions of a central bank as the Bankers’ Bank?
Operates interbank payments network
Provides loans during crises
Oversees financial intermediaries to ensure safety and soundness
Who are the main players and their roles in the money supply process?
Central bank: Conducts monetary policy.
banks: financial intermediaries, accept deposits, and make loans.
depositors: Hold deposits in banks.
borrowers: Borrow funds from banks.
What are the main liabilities of a central bank?
Currency in circulation
Reserves (bank deposits at the CB and vault cash)
How is total reserves calculated?
Total Reserves = Required Reserves + Excess Reserves
What are the main assets of a central bank?
Government securities (CB holdings of Treasury securities)
Discount loans (provide reserves to banks and earn the discount rate)
How do government securities and discount loans affect the money supply?
Both impact the total money supply by influencing the availability of reserves.
What are the key assets of a commercial bank?
Reserves and cash items
Securities
Loans
Other assets
What are the key liabilities of a commercial bank?
Checkable deposits
Non-transaction deposits
Borrowings
Bank capital
What is the formula for the monetary base (High-powered money)?
𝑀𝐵=𝐶+𝑅
C = Currency in circulation
𝑅 = Total reserves in the banking system
What happens when the central bank buys a £100 bond from a commercial bank?
The central bank pays with a £100 check.
Reserves increase by £100.
No change in currency.
Monetary base increases by £100.
What happens when the central bank buys a £100 bond from an individual, and the check is deposited in a bank?
The person deposits the CB’s check in a bank.
Identical result as purchasing from a bank.
Reserves increase by £100.
No change in currency.
Monetary base increases by £100.
What happens when the central bank buys a £100 bond from an individual, and the check is cashed instead of deposited?
The check is cashed, so currency in circulation increases.
Reserves remain unchanged.
Monetary base increases by the amount of the open market purchase.
How does an open market purchase affect reserves?
It depends on whether the seller keeps the proceeds in cash or deposits.
How does an open market purchase affect the monetary base?
It always increases the monetary base.
What happens when the central bank sells a £100 government bond?
The monetary base decreases by £100.
Reserves remain unchanged.
Why is the effect of open market operations on the monetary base more certain than on reserves?
Because reserves can fluctuate due to various factors, while the monetary base changes directly with central bank actions.
What is the net effect on the central bank’s monetary liabilities when deposits shift into currency?
Zero net effect.
What happens to reserves when depositors withdraw cash?
Reserves decrease by the amount withdrawn.
Reserves vary according to random fluctuations
How does a shift from deposits to currency affect the monetary base?
The monetary base remains relatively stable despite fluctuations in reserves.
How can the central bank (CB) change the monetary base through discount loans?
By granting or recalling discount loans to banks.
How does a discount loan appear on the balance sheet of the banking system?
Assets increase: Reserves +£100.
Liabilities increase: Loans +£100.
What happens when the CB makes a £100 discount loan to a bank?
The monetary liabilities of the CB increase by £100.
The monetary base increases by £100.
What happens when a bank pays off a £100 discount loan to the CB?
The monetary base decreases by £100.
The monetary base changes one-for-one with changes in CB borrowings.
How does repaying a discount loan appear on the balance sheet of the banking system?
Assets decrease: Reserves -£100.
Liabilities decrease: Loans -£100.
What are two factors that affect the monetary base but are not under the CB’s control?
Float and Treasury deposits at the CB.
How does float affect the monetary base?
Due to the CB’s check clearance system, crediting occurs before debiting.
This creates temporary excess reserves.
How do Treasury deposits at the CB affect the monetary base?
When funds are transferred from commercial banks to the CB, reserves decrease.
Can the CB control Treasury interventions in foreign exchange markets?
Yes, the CB can control these fluctuations.
What is the formula for the monetary base (MB) in terms of reserves?
MB = MBn+BR
Where:
𝑀𝐵 = Monetary base
𝑀𝐵𝑛= Non-borrowed monetary base
𝐵𝑅 = Borrowed reserves
Why does the CB split the monetary base into borrowed and non-borrowed components?
Because there is uncertainty about loans to financial institutions, but the CB has full control over open market operations.
How does the CB maintain control over the monetary base despite fluctuations in borrowed reserves?
By adjusting the non-borrowed monetary base through open market operations to hit a target monetary base.
What is the formula for the money supply (M)?
M=M1=C+D
C = Currency in circulation
𝐷 = Deposits
How does the central bank (CB) manipulate the money supply, and what is the role of the simple model of deposit creation?
The CB influences the money supply (𝑀=𝐶+𝐷) by controlling the monetary base (𝑀𝐵). To understand this process, we need to link
𝑀𝐵 to deposits (𝐷). The simple model of deposit creation explains how multiple deposits can be created from an initial injection of reserves.
What happens when a bank sells securities to the central bank (CB)?
The bank’s reserves increase as it receives money from the CB.
What does a bank do with increased reserves?
It can use excess reserves to grant loans, which increases deposits to make money available.
Borrower uses the money to purchase goods.
Money from deposit gets paid to other banks
Why must banks avoid granting loans higher than their excess reserves?
Because the loaned money gets spent and transferred to other banks, reducing the lending bank’s reserves.
What happens when a borrower deposits money into Bank A?
Bank A’s reserves increase.
If the required reserve ratio is 10%, Bank A can lend out excess reserves.
How does the loan process create money?
Deposits increase by £100.
Bank A keeps 10% (£10) as reserves.
The remaining £90 is loaned out, which creates new deposits.
What happens when loans from Bank A are deposited into Bank B?
Bank B’s reserves increase by the loan amount.
Bank B keeps 10% as required reserves and lends out the rest.
How does multiple deposit creation work?
The loan from Bank A (£90) is deposited in Bank B.
Bank B keeps 10% (£9) in reserves and lends out £81.
This process continues, creating new deposits at each step.
What is the total increase in deposits with a 10% reserve ratio?
The total increase in deposits is tenfold the initial deposit due to the money multiplier effect.
How does the multiplier effect work when banks use excess reserves to buy securities?
Payments for securities create new deposits.
These deposits generate new reserves.
Excess reserves are used to buy more securities, repeating the cycle.
Why can a single bank not grant loans greater than its excess reserves?
Because the money from loans is spent and transferred to other banks, reducing the lending bank’s reserves.
How does the central bank’s (CB) initial action propagate through the banking system?
The CB’s initial stimulus increases reserves.
Banks use excess reserves to grant loans or buy securities.
This process creates more deposits and reserves, amplifying the money supply.
