Chapter 8.1: Central Bank Flashcards
Central bank
is a monetary institution, which fully controls the production, circulation, and the supply of money in the market, seeking to regulate the member banks and stabilize a nation’s economy and national currency
The Federal Reserve System, also known as the Federal Reserve bank or the Fed for short, is one of the largest and most influential central banks in the world.
The Fed:
- is an independent entity that is privately owned by its member banks.
- is subject to oversight from Congress that periodically
reviews its activities. - supervises and regulates the nation’s financial institutions and simultaneously serves as their banker.
The structure of FED:
- The Federal Reserve Board of Governors (FRB) which mainly assumes regulatory and supervisory responsibilities over member banks. (7 members)
- The Federal Open Market Committee (FOMC): comprises 12 members
+ 7 members of the Federal Reserve Board of Governors
+ President of the Federal Reserve bank of New York
+ 4 of the regional Federal Reserve bank presidents - The FOMC convenes eight times a year to decide on the interest rates and monetary policy.
The Federal Reserve Bank of New York plays a special role in the Federal Reserve System for several reasons.
- First, its district contains many of the largest commercial banks in the United States, the safety and soundness of which are paramount to the health of the U.S. financial system.
- Second is its active involvement in the bond and foreign exchange markets.
The 12 Federal Reserve banks are located in major cities throughout the nation
.
Monetary policy is more effective when a central bank is more independent.
There are two key dimensions of central bank independence.
+ Goal independence: insulate the central bank from political influence in defining its monetary policy objectives.
+ Instrument independence: which refers to the ability of the central bank to freely implement policy instruments in its pursuit to meet the monetary goals.
4 main functions of central bank
(1) Sole Right of Note Issue
- The central bank is given the sole right of issuing note in order to secure control over volume of note and credit.
- These notes circulate throughout the country as legal tender money. It has to keep a reserve in the form of gold and foreign securities as per statutory rules against the notes issued by it.
4 main functions of central bank
(2) Controller of Credit and Money Supply
- Central bank controls credit and money supply through its monetary policy which consists of two parts—currency and credit. Central bank has monopoly of issuing notes and thereby can control the volume of currency.
- The main objective of credit control function of central bank is price stability along with full employment.
4 main functions of central bank
(3) Banker to Government
- Carries out all banking business of the government. It accepts receipts and makes payment on behalf of the governments.
- Carries out exchange, remittance and other banking operations on behalf of the government.
- Gives loans to governments for temporary periods and when necessary and it also manages the public debt of the country.
4 main functions of central bank
(4) Banker to Commercial Banks
- Regulate and supervise commercial banks
+ Commercial banks are required to keep a certain percentage of their deposits with the central bank; and in this way the central bank is the ultimate holder of the cash reserves of commercial banks.
+ Central bank is lender of last resort. Whenever banks are short of funds, they can take loans from the central bank and get their trade bills discounted. The central bank is a source of great strength to the banking system.
5 roles of central bank
(1) Price Stability
The central bank is responsible for contributing to the formulation of monetary policy and helping to ensure that the inflation objective is achieved. The primary objective of the monetary policy is to maintain price stability.
5 roles of central bank
(2) Currency Stability
Acurrencyisstablewhen the general level of prices, measured by the Consumer Price Index, does not vary too much. As it is responsible for pricestability, thecentral bankmust regulate the level of inflation by controllingmoneysupplies by means of monetary policy.
5 roles of central bank
(3) Stability of the Financial System
- The central bank has an explicit mandate in financial stability. It does so by enhancing the macro-prudential policy framework by:
+ developing a suite of indicators to assess systemic risks,
+ developing macro-prudential tools to address emerging risks,
+ conducting analytical research to inform on the calibration of these tools,
+ evaluating the effectiveness of these tools in limiting systemic risk.
5 roles of central bank
(4) Regulation of Financial Institutions and Enforcement Actions
- The central bank aims to ensure that regulated firms are financially sound and safely managed.
- Regulation of financial institutions and markets is undertaken through risk-based supervision, which is underpinned by credible enforcement deterrents.
5 roles of central bank
(5) Foreign exchange regimes and policies (chính sách ngoại hối)
Note: Exchange rate regime (Chế độ tỷ giá hối đoái) là cách thức một đất nước quản lý đồng tiền của mình liên quan đến các đồng tiền nước ngoài và quản lý thị trường ngoại hối.
The choice of a monetary framework is closely linked to the choice of an exchange rate regime.
- A country that has a fixed exchange rate will have limited scope for an independent monetary policy compared with one that has a more flexible exchange rate.
- Although some countries do not fix the exchange rate, they still try to manage its level, which could involve a trade off with the objective of price stability.
- A fully flexible exchange rate regime supports an effective inflation targeting framework.
