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P. 35. Central banking and monetary policy, p. 515.

Functions of central banks

1. government's banker
2. Bankers bank
3. Lender of last resort to LDMA
4. banking supervision
Controls that the banks don't operate against the Bank policy (creates inflation)
Liquidity supervision
Bad debts management
5. Note issue
6. Operating monetary policy
7. Foreign exchange transactions (Exchange equalisation account)
8. Sells stock
9. Advisory services and statistical information
10. manages national debt

Balance sheet



Issue department (16m)

Liabilities Assets

Notes in circulation and in banking dept.

Government and other securities

Banking department (4.5m)

Capital, deposits and reserves

notes, advances, govn securities, premises

Monetary policy - direction of the economy through supply & price of money.

Early changes

It was believed until Keynes that low interest rates stimulate economy. Thus they varied a bit. UK was in gold standard - no change in money supply. 1930 interest + investment low, Keynes said liquidity trap. After war his policies where used, but interest still low, because large savings and govn borrowing, socialist govn thinking fiscal policy is fairer and didn't like to punish govn security buyers.

In 1950s and 1960s

Increasing interest would decrease security price making institutions unwilling to sell them and choking off investment. Liquidity control was top priority. Main policy fiscal, monetary for fine tuning.

After 1970 rise of monetarist

Liquidity ration lowered - resulted in inflation. Interest left for market forces. 1979 conservatives started to strict money supply. Main policy was and is now monetary. Too much is expected from it.

The stages of monetary policy

1. Instruments or weapons of policy

a. The issue of notes and coins
b. Liquidity ratios - multiplier effect on credit creation. Excess liquidity exists.
c. Interest rates (decreasing might not increase investment whereas raising locks up funds, because most investment decisions are non-marginal. Time also varies. Government pays interest on national debt. Also the hot money flows in)
d. Open-market operations (sale of govn securities). The general public must buy them because banks regard them as liquid assets.
e. Funding (converting short-term debt into long-term), expensive.
f. Special directives and deposits (damage relationships between the Bank and commercial banks, very effective)
g. Moral suasion (in USA)

2. Operating policy targets (e.g. liquidity of banks)

3. Intermediate targets (money stock (if raises the velocity can fall!), volume of credit, interest rates, exchange rate, expenditure in the economy)

4. Aggregate demand changes , that will directly lead to

5. Overall policy options - inflation economic growth etc.


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