Topic 5 Flashcards
2 functions of a CB for a government?
Creates money
Controls availability of money and credit
3 functions of a CB for bankers?
Provides loans in difficult times
Manages payment system
Overseas commercial banks and the financial system
5 objectives of a central bank (and main 2)?
PRICE STABILITY ECONOMIC GROWTH Financial system stability Interest rate stability Exchange rate stability
When is it particularly important for the CB to prioritise exchange rate stability?
When a country relies heavily on exports
Why do the CB aim to keep inflation low (3)?
It degrades info on prices
Makes money a less useful store of value tf
Makes loans harder to make and harder to save properly
3 problems with deflation?
Postpones consumption
Debt becomes more expensive to repay
Banks reluctant to lend
Why is a small amount of inflation good?
Helps the labour market to work
Wages constant but inflation causes real wage costs to fall for employers
How does the CB control economic growth?
Interest rate adjustments help to keep business cycles smooth and tf stabilise growth and employment
How?
LR production level depends on things like technology, size of capital stock and workforce
Increase in those -> increase potential output tf sustainable growth tf growth
Why do CBs keep financial markets stable?
They allow efficiency in the economy - risk of disruption is a systematic risk (will affect all, also known as undiversifiable or market risk)
What is idiosyncratic/diversifiable/unique risk?
Risk that only affects a small number of people
3 ways to reduce risk and brief explanation?
Diversification (reduces idio risk)
Hedging (reducing risk by making opposing risks)
Spreading (reducing risk by making unrelated investments)
See risk graph
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Why is interest rate stability an objective of the CB?
If IR are volatile, people borrow and save less because of the uncertainty therefore fall in efficiency
Why is exchange rate stability an objective of the CB?
Value of currency affects X and M tf a stable ER allows firms to plan international trade better tf higher efficiency and growth
4 principles of CB design?
1) independence (freedom from political influence)
2) decision making by committee (more than one person tf better decisions)
3) accountability+transparency (policy makers held accountable to public)
4) policy framework (policymakers have to state goals and explain trade offs between them)
How is the BofE transparent?
Inflation reports every quarter and publish bank sheets regularly
3 branches of the Federal reserve system?
12 regional fed banks distributed across US
Central government agency (board of governors of the federal reserve system in Washington)
Federal open market committee (FOMC)
Describe the board of governors? (2)
- 7 members appointed by president
- confirmed by US senate for 14-year terms
5 duties of the the board of governors?
- sets reserve requirement
- approves and disproves discount rate recommendations
- regulates banking system
- analyses financial and economic conditions
- collects and publishes detailed statistics
What does the FOMC do?
Sets federal fund rate
What is the federal fund rate?
The rate which banks charge each other for loans on their excess deposits at the fed
See page 137
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European system of central banks (ESCB) = ?
ECB + national central banks (NCBs)
Eurosystem = ?
ECB + NCBs of Euro adopted countries
Three levels of decision making process at EMU (European economic and monetary union)?
The governing council
The executive board
The general council
Explain make up and role of the governing council?
6 members of executive board and governors of NCBs(euro area only)
Role: formulates monetary policy for Euro areas
Explain make up and role of the executive board?
President + Vice President + 4 other members
Role: implements monetary lines of governing council
Explain make up and role of the general council?
President + Vice President + representatives of 28 EU member states
Role: advises ECB, collects stats, standardises accounting operations of NCBs
2 branches of Bank of England?
The court (governor + 2 deputy governors + 16 non executive directors)
Monetary policy committee (governor + 2 deputy governors + 2 members appointed by governor + 4 economics exports appointed by chancellor)
Role of MPC?
Sets interest rates
What happens if the inflation rate isn’t reached?
Governor has to write a public letter to the chancellor explaining why
4 sections of a CBs balance sheet?
Governments bank:
Assets - securities, forex reserves
Liabilities - currency, gov’s account
Bankers bank:
Assets: loans
Liabilities: accounts of commercial banks (reserves)
What happens to the CBs balance sheet if there’s an increase in assets? (2)
An equal increase in liabilities
OR
An equal decrease in another asset
Tf still balances
Explain each of the assets to the CB?
Securities: main asset, quantity held is controlled through open market operations (buying and selling)
Forex reserves: held in form of bonds issued by foreign governments
Loans: loans made to commercial banks
Explain each of the liabilities to the CB?
Currency: currency circulating hands of nonbank public (main liability)
Gov’s account: CB provides an account into which gov deposits and from which they make payments
Commercial bank accounts (reserves): deposits at CB + cash in own vault
2 types of reserves?
Required
Excess
What is meant by disclosure of the CB?
Every CB has to publish its balance sheet tf is held accountable for its’ actions
Monetary base (high powered money) = ?
Currency in hands of public + reserves in banking system
Which side of the balance sheet can the CB change the composition of?
Assets
4 ways to change the composition of balance sheet?
Open market operations - buying or selling a security by the CB
Foreign exchange intervention - buying or selling of foreign exchange reserves (normally to influence ER)
Extend a discount loan - initiated by commercial banks
Cash withdrawal - withdrawal from nonbank public
See pages 149-152
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