1

Functions of a central bank

act as banker to the government act as banker to the commercial banks supervise the banking system

print and issue banknotes

maintain financial stability conduct foreign exchange operations hold and manage foreign exchange reserves
2

The Bank of England

Two core purposes: 1. Ensuring monetary stability 2. Maintaining the stability of the financial system

The Bank of England

Tasks to ensure monetary stability: Try to meet the governments inflation target by raising or lowering the official interest rate when necessary. Use the UKs foreign currency and gold reserves to try to influence the exchange rate if needed.

The Bank of England

Tasks to maintain the stability of the financial system : Detect and reduce any threats to the financial stability, and make sure the overall system is safe and secure. Supervise the clearing system: the settlement of claims between banks Act as lender of last resort to financial institutions in difficulty.
5

THE EUROPEAN SYSTEM OF CENTRAL BANKS (ESCB)

Composed of: The European Central Bank, and The EU national central banks

THE EUROPEAN SYSTEM OF CENTRAL BANKS (ESCB)

ESCBs primary objective: to maintain price stability ESCBs basic tasks: define and implement the monetary policy of the EU; conduct foreign exchange operations; hold and manage the official foreign reserves of the Member States; and promote the smooth operation of payment systems.
7

THE EUROPEAN CENTRAL BANKS (ECB) Organisation of the ECB executive board

President

Vice-President

Member

Member

Member

Member

THE EU NATIONAL CENTRAL BANKS (NCBs)

Having all the functions of a central bank except setting interest rates

US FEDERAL RESERVE SYSTEM (The Fed)

The Fed has two divisions: Board of Governors, is responsible for setting monetary policy and managing the nation's money; 12 Regional Reserve Banks, act as the service division that carries out the policy and oversees financial institutions. The regional Reserve Banks represent the private sector.
10

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

Monetary policy refers to the actions the Fed takes to influence financial conditions in order to achieve its goals. In its role as money manager, the Fed has two primary goals: Maintain stable prices (control inflation) Ensure maximum employment and production output
11

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

Inflation: Inflation is not a good thing because it slows down economic growth. For example, when inflation is high, things cost more and people spend less. When people don't buy things (when demand is down), then the supply of goods gets too high, production has to decrease, and unemployment increases.
12

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

13

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

When prices are stable (when inflation is low), consumers make more purchases, investments, etc., production output is maintained and employment remains high.
Recession: When production decreases and unemployment increases, recession hits.
14

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

15

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

Feds tasks to achieve its goals: To achieve its goals, the Fed can indirectly influence demand, which then influences the economy. For example, if interest rates are lowered, borrowing money to make purchases becomes less expensive, and people are more motivated to spend money. Spending money, in turn, stimulates economic growth.
16

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

If there is too much money in the economy, however, people spend more money and demand increases at a faster rate than supply can match. Prices rise too quickly because of the shortage of products, and inflation results. If there is too little money in the economy, people don't have excess spending money, and there is little economic growth.

17

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

18

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

Influencing inflation takes a long time and has to be looked at as a long-term goal. Influencing employment and output, however, can be done more quickly and therefore is a short-term goal. Finding the balance between the two is key.

19

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

The Feds primary control is influencing shortterm interest rates and the amount of money in circulation. In doing this, it uses three tools: Open market operations The discount rate The reserve requirement

20

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

1. Open market operations
The most effective tool the Fed has, and the one it uses most often, is the buying and selling of government securities in its open market operations. Government securities include treasury bonds, notes, and bills. The Fed buys securities when it wants to increase the flow of money and credit, and sells securities when it wants to reduce the flow.
21

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

1. Open market operations: How does it works? The Fed purchases securities from a bank and pays for the securities by adding a credit to the bank's reserve. The bank has more money to lend to another bank in the federal funds market. This increases the amount of money in the banking system and lowers the federal funds rate. This ultimately stimulates the economy by increasing business and consumer spending.
22

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

1. Open market operations: How does it work? When the Fed wants to decrease the money supply, it sells securities. This reduces the amount of money the bank has to lend in the federal funds market and increases the federal funds rate. This move ultimately slows the economy down because it typically reduces consumer and business spending.
23

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

2. The discount rate
The "discount rate" is the interest rate that a regional Reserve Bank charges banks and financial institutions when they borrow funds on a shortterm basis. Typically, higher discount rates indicate that more restrictive monetary policies are in store, while a lower rate might signal a less restrictive move.

24

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

2. The discount rate
Changes in the discount rate can affect: Lending rates (by making it either more or less expensive for banks to get money to lend or hold in reserve) Other open market interest rates in the economy (because of its "announcement effect")

25

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

3. The Reserve requirement This refers to the proportion of deposits a bank must hold in its reserves as it lends the rest out. The amount of a bank's required reserves will fluctuate depending on their account totals (from 3% to 10%).

26

US FEDERAL RESERVE SYSTEM (The Fed) Monetary policy

3. The Reserve requirement If the reserve requirement is raised, then banks have less money to loan and this will have a restraining effect on the money supply. If the reserve requirement is lowered, then banks have more money to loan.

27