role of central banks Flashcards
what does the central bank do?
manages the currency, money supply and interest rates in an economy
how does the central bank implement monetary policy?
- central bank takes action to influence the manipulation of interest rates, supply of money and credit, and the exchange rate
- in the UK the MPC (Monetary Policy Committee) alters interest rates to control the supply of money
- they are independent from the govt
- the nine members meet each month to discuss what the rate of interest should be
- interest rates are used to help the govt target of price stability as it changes the cost of borrowing and reward for saving
- bank controls base rate, which ultimately controls interest rates across the economy
how does the central bank act as a banker to the govt?
- provides services to central govt
- collects payments to the govt and makes payments on behalf of the govt
- maintains and operate deposit accounts of the govt
- also manages public debt and issue loans
- can advise the govt on finance, including the timing and terms of new loans
how does the central bank act as a bank to banks?
- BoE is considered to be the lender of last resort
- if theres no other method to inc supply of liquidity when its low, BoE will lend money to inc supply
- if an institution is risky/ close to collapsing the bank may lend to them when they have no other way to borrow money
- can protect individuals who deposit funds in a bank and might otherwise lose them
- aims to prevent consumers withdrawing their bank deposits if they believe the bank will fail
why do banks avoid borrowing from the lender of last resort?
usually banks will avoid borrowing from the lender of last resort as it suggests the bank is experiencing a financial disaster
how does the central bank regulate the banking industry?
- govt may regulate banks with regulation and guideline
- this helps to ensure that the behaviour of banks is clear to institutions and individuals who conduct business with the bank
- some economists argue that the banks have a large influence in the economy
- if they failed it would have huge consequences
- therefore its important to regulate the baking industry
what is the UK banking industry monitored by?
UK banking industry monitored by PRA and FCA
what does the FCA do?
- FCA ensures banks are being honest to consumers and seek to protect consumer interests
- FCA also aims to promote competition which is in the interest of consumers
- microprudential regulator
what does the PRA do?
- PRA promotes safety and stability of banks
- building societies, investment firms and credit unions
- ensures policyholders are protected
microprudential regulator
recall the roles of the central bank
implement monetary policy
banker to the govt
banker to banks
role in regulation of banking industry
when would expansionary monetary policy be used
to inc inflation
inc growth
dec unemployment
when would contractonary monetary policy be used
dec inflation
prevent asset/ credit bubbles
reduce excess debt and promote saving
dec CA deficit
what are the problems with monetary policy
expansionary monetary policy may lead to demand pull inflation, CA deficit
could lead to liquidity trap
dec incentive to save -> if someone becomes unemployed its risky as they have no safety due to little savings which could dec living standards
takes a long time for a cut in interest rates to transfer through the different channels in the transmission mechanism -> therefore takes a lng time to inc AD
how can you evaluate the roles of the CB
may lead to moral hazard
bank may not hold sufficient liquidity
regulatory capture
why is it important for the CB to regulate the financial system
for financial stability
keep confidence high
prevent panic and run on banks
