Lecture 3 - Central Banks Flashcards
Main two functions of central banks:
- “the banks for banks” and handles payments between these banks
- They are monopoly issuers of notes and coins.
How is money created?
Through adjustments to “reserve” accounts that banks must keep with their central bank. There are regulations requiring banks to keep a certain amount of funds in these accounts. This is known as open market operations.
How does Open Market Operations work in practice?
- The central bank purchases a security worth $1,000.
Janet then deposits the cheque at her bank:OmoBank. - When Omobank presents the cheque for payment to the Central Bank, the central bank credits OmoBank’s reserve account by $1,000.
- OmoBank can, if they wish, swap these additional reserves for cash to put in ATM machines.
- When OmoBank orders a delivery of cash from the central bank, its reserve account is reduced by that amount.
How else can the central bank create money
by making loans to banks
- To obtain loans from the ECB, banks must pledge some assets to the ECB as collateral. If they fail to repay the ECB, the central bank will take the collateral in lieu of repayment of the loan.
Central banks provide loans by crediting their reserve accounts, creating money from nowhere.
The difference between the current value of assets and liabilities is called:
Capital
What falls under liabilities for a central bank? (right side of the balance sheet)
“Currency in Circulation” and “Reserve Accounts”
- Cash in circulation is not really a liability of the central bank as the central bank does not pay interest on cash notes and does not promise to swap the notes for some other assets or quantity of gold.
Liabilities - the amount of money that has been created.
What falls under assets for a central bank? (left side of the balance sheet)
Securities and Loans
Why are central banks involved in banking supervision?
to check that banks are complying with their rules.
Why do central banks play an important role in payment systems?
because all banks maintain reserve accounts with their central bank, this puts the central banks at the very centre of the banking system.
This gives them an advantage over other institutions in facilitating payments between banks.
Why are central banks usually given a mandate to maintain financial stability?
Do central banks need to have assets exceeding liabilities?
No
Central bank balance sheets list the money they have created as “Liabilities”.
However, once printed. it does not cause any further costs to the central bank.
At present central banks are making interest payments on reserves that are often larger than the interest they are earning on the fixed-rate securities they bought during the low-interest-rate era.
What is the reason for risk control in managing central bank assets?
- Opportunity Cost: Instead of acquiring a particular asset, the money could have been used to buy an asset which gave the central bank a return and this return could have been passed back to central government.
- Indirect Cost: Because expansions in the supply of money can produce inflation, printing money can create an indirect cost by making goods and services more expensive.
