Th4.4: Role of the Central Bank

Question 1

How does the central bank control monetary policy?

Answer 1

through interest rates and controlling money supply in order to keep inflation low and stable

Question 2

What does it act as to the government?

Answer 2

a banker - often hold the government’s bank account and lend to them, holding government debt, as well as holding gold and foreign exchange reserves

Question 3

Act as bank to other banks

Answer 3

banks deposit their money within the central bank and this is often used to balance the accounts of banks at the end of each day, when banks owe each other money because cheques have been paid in by consumers e.t.c

Question 4

What is the most important role of the central bank acting as a bank to the other banks?

Answer 4

the fact they are a lender of last resort - if banks experience liquidity problems, they can turn to the central bank to sell their liquid assets or to take a loan in the short term - can also prevent them collapsing

Question 5

Why will the collapse of one bank often lead to one of another?

Answer 5

banks tend to lend to each other

Question 6

Why is it important to regulate the financial system?

Answer 6

important to prevent financial institutions from undertaking activities which harm consumers or engage in risky activities which would lead to the collapse and therefore the whole system collapsing

Question 7

Why does the financial sector play a huge role in the economy?

Answer 7

because it impacts investment and can cause huge externalities if market failure occurs