Chapter 12: The Function of Central Banks

Question 1

Central banks were created for the purpose of 8 main reasons

KNOW 4

Answer 1

• Produce and distribute the currency.
• Maintain interest rate stability.
• Control the rate of inflation.
• Manage the money supply.

Question 2

3 Different Names for Central Banks and the difference in functions

Answer 2

• Central banks (Bank of Canada)
• Reserve banks (Reserve Bank of India)
• Monetary agencies/authorities (Saudi Arabian Monetary Agency)

Functions are essentially the same

Question 3

4 Reasons Central Banks focus on Monetary Policy KNOW 2

Answer 3

• Contributing to the continued upward performance of the economy of the country.
• Raising the standard of living (the quality of life) for the residents of the country.
• Keeping inflation low, stable, and with some measure of predictability.
• Interest rate management

Question 4

The three more commonly pursued monetary targets of central banking include

Answer 4

1. Price stability
   - Controlling Inflation
2. Exchange rate values
   - attempting to prevent their home currency from losing too much value against the currencies of its key trading partners
3. GDP influencing
   - (contraction or expansion)

Question 5

The four main instruments of monetary policy used by central banks

Answer 5

1. Open market operations.
   - buy or sell securities that will either contract or expand the money supply
2. Interest rate adjustments.
   - bank rate (what central banks charge to commercial banks for loans)
   - overnight rate (what banks charge to each other for bank loans)
   - prime rate (actual rate borrowers get high high credit scores 1.75% over bank rate)
   - Slow economy / decreased interest rate
   - Inflated economy / increased interest rate
3. Reserve requirements upon the banking sector.
   - Keep larger amounts of reserve to decrease money supply
   - reduce reserves to increase money supply
4. Moral suasion.

Question 6

3 critical concepts of independence of central banks

Answer 6

Trust
-That lack of faith could, in turn, spill over into a lack of faith in the entire banking system within that country

Transparency
-information about what has been done, is being done or is planned to be done, is made available in the public domain

Credibility

• effective leadership
• do exactly what they say they will do

Question 7

Monetarism

Answer 7

actions of a central bank that will lead to changes in the money supply.

significant influence upon short-run GDP and long-run prices

Question 8

Monetarist Theories to increase money supply

Answer 8

1. Reducing interest rates
   - leads to more companies and individuals borrowing money
2. Purchasing investments
   enabling central banks to transfer more money to financial institutions, increasing the money supply available

Question 9

Six factors are the most important elements to how the Bank of Canada is Organized and operates

KNOW 3

Answer 9

1. The head of the Bank of Canada (its Governor) and the Senior Deputy Governor are appointed by the Bank of Canada’s independent board of directors, not by the federal government.
2. The Bank of Canada’s budget and financial requirements are approved by the board, not the federal government.
3. The Bank’s annual, quarterly and special reports and reviews are freely available to the public.

Question 10

Bank of Canada’s 5 Main Responsibilites

Answer 10

1. Monetary Policy
   - Formulating and executing monetary policy
   - growth of economy and standard of living
   - Control Inflation
2. Currency
   - issuing, distributing, and managing the supply of currency
3. Financial system
   - supervising and supporting banks
   - safe, stable and efficient
   - conducting financial transactions and regulatory activities