Central Bank

Question 1

What are central banks?

Answer 1

They manage the state’s currency, money supply, interest rates and print the national currency.

Question 2

What are the main functions of central banks?

Answer 2

• implement monetary policy and exchange rate policy
• management of national debt
• supervision of the banking sector
• acting as a lender of last resort

Question 3

What are the long term objectives of central banks?

Answer 3

-price stability
-high employment
-stable economic growth
All done through monetary policy

Question 4

What are the main tools used by central banks?

Answer 4

• open market operations
• the discount rate
• reserve requirements ratio

Question 5

What is monetary policy?

Answer 5

Actions taken by central banks to influence the availability and cost of money. It is used to create low and stable inflation.

Question 6

What are open market operations?

Answer 6

Buying and selling of government bonds (securities) by the central bank.
Allows control over the amount of bonds bought. Is also a flexible and precise form of monetary policy that is quickly implemented and easily reversed

Question 7

What is the reserve requirement ratio?

Answer 7

Increasing the RRR decreases the bank’s excess reserves making the money supply decrease.
This can cause liquidity problems and increases uncertainty

Question 8

What is the discount rate?

Answer 8

The rate that central banks charge for loans to commercial banks. Borrowing causes reserves of commercial banks to increase. High discount ate discourages borrowing which restricts the money supply.
It is hard to predict the impact a change in the discount rate will have on the money supply

Question 9

What is expansionary monetary policy?

Answer 9

Central banks increase the money supply through:
-buying securities in OMO
-lowering the discount rate
-lowering the RRR
This increases the money supply, lowers interest rates, increases borrowing and increases credit availability which helps reach the ultimate macroeconomic objectives.

Question 10

What is contractionary monetary policy?

Answer 10

Central bank decreases the money supply through:
-selling securities in OMO
-raising the discount rate
-raising the RRR
This decreases the money supply, increases interest rates and reduces borrowing which helps reach the ultimate macroeconomic objectives

Question 11

What is the impact of changing the discount rate?

Answer 11

Increasing= funds borrowed decreases
Decreasing= funds borrowed increases

Question 12

What is the impact of changing the reserve requirement ratio?

Answer 12

Increasing= available funds decrease
Decreasing= available funds increase

Question 13

How does the central bank provide a supervisory function?

Answer 13

The central bank is involved in licensing deposit taking institutions and monitoring how well these institutions are managed. They focus on monitoring capital adequacy, liquidity and risk profile.

Question 14

How does the central bank act as a lender of last resort?

Answer 14

They provide liquidity to financial institutions if they are struggling to maintain sufficient liquidity

Question 15

In what ways do central banks help maintain financial stability?

Answer 15

• provide a supervisory function
• act as a lender of last resort
• help with the settlement of payments (act as a clearing system for banks transferring money to each other)

Question 16

When are unconventional monetary policy tools used?

Answer 16

When conventional policy becomes ineffective in deep recession and economic crisis

Question 17

What is quantitative easing?

Answer 17

The central bank creates new money electronically to buy financial assets. This aims to directly increase private sector spending in the economy and return inflation to target.

Question 18

How does quantitative easing work?

Answer 18

1. central bank creates money…
2. to buy bonds from financial institutions
3. which reduces interest rates
4. leading to people/businesses borrowing more
5. so they spend more and create jobs
6. which boosts the economy

Question 19

What are the advantages and disadvantages of quantitative easing?

Answer 19

Advantages
-low interest rates for households and firms
-stimulates job creation
-prevents severe downturn 
Disadvantages
-can create a new financial crisis
-increases inflation 
-punishes savers

Question 20

What is negative interest rate policy?

Answer 20

A form of unconventional monetary policy where a nominal target interest rate is set with a negative value. This encourages banks to lend money cheaply and encourages savers to spend more freely. It discourages overseas money flowing in and stops this pushing currencies lower.