Central Banking

Question 1

Overview of CB functions

Answer 1

Why CB systems

• Predictability of inflation and interest rate
• Promote economic growth and increase employment
• Safety and soundness of banking system
• Government debt; national reserves, payments, exchange rates

Central banking functions
- Set monetary policy
- Supervise the banking and financial systems
- Safeguarding the confidence and stability of the banking system
Other functions
-Payment systems among banks and financial institutions
- The Governments bank
- Management of foreign exchange rates
- Hold national reserves

Question 2

Monetary policy

Answer 2

• Managing the amount of money and the interest rates in an economy
  The context
• Banker to banks
  Legislated rate to accept deposits from other banks
  Set up required returns
  Liabilities of CB

Money base

• MO = currency in circulation + reserves
• Reserves + required reserves + excess reserves

Money Supply

• Narrow money i.e. the money base MO
• Broad money i.e. narrow money, current and time deposits, money market instruments
• Broad money x7 the money base
• CB can use money base to create broad money: credit multiplier
• Often market ops
• Setting the required reserve ratio
• Setting the rate of discount window borrowing

Question 3

Open Market

Answer 3

Buying and selling the governments securities on the secondary money market;

• Buying increase money base
• Selling decreases
• On day to day basis

Repo

• Repo - securities are sold at an agreed price with a promise to buy back at a specified time
• Reverse repo - securities are bought at an agreed price with a promise to sell back
• Interests are paid via the price differences
• Influencing over night interest rate using repo; equilibrium interest rate, interest rate decrease when supply of reserve increases

Question 4

Change required reserve ratio

Answer 4

• Increase ratio: banks demand more reserve; interest rate increases, money supply decreases
• Decrease ratio
• A change in the required reserve shift the reserve demand curve
• Drawback: inflexible, infrequent, big impact

Question 5

Discount window borrowing

Answer 5

• Borrow additional reserves
• Those above the required amount can be lent out
• Discount loans have to be repaid
• Discount interest rate is higher than the money market rate
• Can provide large amount of volume of money supply
• Typically short term
• Rarely used
• Drawback; difficult to accurately change money supply

Question 6

Impact on monetary policies on economy

Answer 6

Objectives of monetary policy

• Stable price
• Low unemployment
• Growth of economy
• Stable interest rates
• Sustain international trade

Question 7

Expansionary monetary policy

Answer 7

Actions;
- Purchase securities on the secondary money markets 
- Reduce required rate of reserves 
- Reduce discount borrowing rate 
- Announce low target rates of interest  
Impacts on financial economy;
- Greater money and credit supply 
- Decreases interest rates 
- More borrowing 
- Currency depreciation 
Impact on real economy;
- Increased inflation 
- Increased employment 
- Economic growth

Question 8

Safeguarding the banking system

Answer 8

Safeguarding

• Bank supervision : CAMELS
• Bank safety; deposited insurance, lender of last resort

CAMELS

• Capital adequacy
• Asset quality

Question 9

Safeguarding the banking system

Answer 9

Safeguarding

• Bank supervision : CAMELS
• Bank safety; deposited insurance, lender of last resort

CAMELS

• Capital adequacy
• Asset quality
• Management
• Earnings
• Liquidity
• Sensitivity to market risk