4.8 Role of the central bank Flashcards
What are the roles of a central banks?
- Monetary policy - interest, QE, Exchange rates
- Financial stability and regulation - supervision of financial system, maintain financial stability
- Policy operation - last report, manage liquidity, oversee payment systems used by banks
- Debt management - handle redemption of issues of debt (bonds)
- Banker to the government
- Issue notes and coins
- Banker to commercial banks - set base rate
What is the MPC and monetary policy in the UK?
- BofE promotes monetary and financial stability
- Stable prices and confidence
- 2% inflation target
- Base interest rate below 1%
MPC does assessment of the UK economy 8 times a year looking at demand and supply side indicators then decide the interest rate, looking at strength of inflationary pressures and forecast over the next 2
What are the cases for and against low interest rates?
For:
- Low inflationary pressure in HICs
- Phillips curve flattened so can operate more without inflation
- Stimulate investment
- Supports AD and output during austerity
- Reduce risk of deflation
Counter:
- Rise in interest rates control demand for credit and supply of money - controls inflation
- increase mortgage rates cause slowdown in house price inflation, property more affordable over time
- Higher interest increases return to saving
- Higher rates reduce risk of mal investment
What are the risks of raising interest?
- High levels of debt rises in value
- Chokes off investment
- Exchange rate appreciates making exports less compoetitive
- Government debt more expensive
- Economic slowdown - share prices, pension fund assets and dividend incomes.
What is quantitative easing?
- MPC QE programme - £445bn in 2019
- Introduction of new electric money to buy assets mainly bonds from insurance companies, pension funds and commercial banks
- Increased demand for bonds causes increase in price of bonds and price to rise. higher bond prices cause fall in yield on the bond.
Those who sell bonds use the money to buy assets with higher yields such as shares and corporate bonds. Commercial banks receive cash and liquidity
What are the effects that QE works by?
- Wealth effect - lower yields lead to higher share and bond prices
- Borrowing cost effect - lowers interest rate on long term debt
- Lending effect - increases liquidity of banks and increased lending from banks lift incomes and spending in the economy
- Currency effect - side effect of causing exchange rate to weaken, helping exports
What are the arguments for and against QE?
- Non interest monetary policy
- Increases money helps lower price deflation - without it fall in GDP may have been deeper
- Lower long term interest kept business confidence high and given commercial banking systems extra deposits
- QE can lead to a depreciation of the exchange rat which helps improve the price competitiveness of export industries
Against:
- Low interest keeps zombie corporations alive
- inflation of property and share values
- Little to cause increase in bank lending
- Low interest bad for saving
- Low interest and bond yields worry for pension fund investors as they worsen their deficits.
What are the aims of financial market regulation?
- Protect against market failure:
- Interest of consumers
- Limit monopoly power
- Protect borrowers from high interest rates
- Improve access to finance
- Balance interest of uninformed consumers with sophisticated sellers of financial services. - Encourage confidence - promote investment and support trust so people willing to save
- Allow central bank to perform other roles such as leader of last resort
What are bank: assets and liabilities?
Assets are funds help by or owed to banks
Liabilities are funds bank owes or holds on deposits
What is the liquidity ratio?
-Ratio of liquid assets help by a bank to their overall assets - ratio of liquid to assets - capital to liability and assets
Commercial banks must hold enough liquidity to cover expected demands from deposits
What is the capital ratio?
- Measures the funds it has in reserve against the riskier assets it holds which are vulnerable
- banks need to reserve sufficient capital including money raised from selling new shares to investors and retained earnings
What is interbank lending and the LIBOR?
- Interbanking lending is lending between banks to manage short run liqudity, uses the central base rate
- LIBOR is the interest rate used for interbank lending
What are some ways of regulating banks?
Financial policy committee - indentify monitor and take actions to remove risks threatening the financial system. May then tell banks to increase capital buffers to absorb unexpected losses on assets
Capital is forced to be held which can absorb losses during an economic downturn and continue lending to the economy. They are leftover funds taken from borrowers. These buffers can be used counter cyclically. In times of predicted recession banks may have to build up extra capital reserves to absorb losses
Prudental regulation is being careful at times of uncertaintly. The Prudental Regulation Authority manages 1,700 banks
Micro prudental - indivudal firsm such as commercial banks, insurance and lenders
Macro prudental - safegaurd financial system as a whole
Stress tends - simulations of losses of GDP, unemployment and inflation rates
Limits to high leverage mortgage lending
What are some failures and some interventions in the financial market sector?
Externalities:
- Increased capital requirements for commercial banks
- Stress tests
- Limits to high leverage mortgage lending
herd behaviour and bubbles:
- FPC voersees financial stability
- MPC can raise interest rates to reduce risk of unsustainable asset price rises
- Regulation of use of volatile crypto currencies
Monopony power/rigging:
- Competition policy
- Price capping on interest rates charged
- More licences to challenger banks to improve contestability
Asymmetric information:
- Penalties for miss selling
- Improved financial education
