Week 5 Deck Flashcards
What are central banks activities and responsibilities?
• Monetary policy
- Implement policies to meet monetary objectives, for examples, price stability, employment, growth etc - Sets monetary policy instruments to achieve its monetary objective • Supervisor for banking system - To ensure stability - Licensing, liquidity and large exposure rules and capital adequacy • Banker for banking system - Banks hold accounts with CB for reserves on deposits and day-to-day activities • Banker for government - Hold's governments bank account and performs some banking operations for the government • Manager of national debt - BoE is large holder of government debt - As of September 2019, it held 23% of the value of governments debt - Influences the structure of the interest rate • Issuer of national currency - Controls the issue of bank notes and coins (legal tender) • Manager of currency reserves - A governments reserves of gold and foreign exchange are held at the CB • Lender of last resort to - The banking system to provide emergency liquidity to banks - The government to provide liquidity in a crisis - Helps to stabilise expectations in the economy
Draw the diagram for the relationship between banks, CB and government
see notes
Who is the LOLR
CB is lender of last resort (LOLR) to both banks and governments
Chain of reasoning for after a government bails out failing banks
Government bails out failing banks -> large increase in sovereign debt -> bond holders lose confidence and sell bonds -> bond prices drop and interest rates increase -> sovereign default risk increases -> CB (LOLR) can step in to buy government bonds to support bond price and prevent interest rates from rising
Why is mutual confidence important within banking systems?
• CB may mitigate fear of government debt default by printing money to buy government bond thus reducing risk premium
- Mutual confidence between the government and CB is important for the governance system:
- Confidence that CB acts as LOLR to government helps stability expectations
Explain how the eurozone crisis was caused
member countries cannot rely on ECB as LOLR to support government bond sales if required
· To bailout Eurozone banks government debt was issued in Euro - ECB was prevented by mandate to act as LOLR - Fear of government illiquidity - Government bond interest rate increased · Eurozone banks are major holders of government bonds - If government bond prices falls, bank solvency problems may arise - doom loop problem · Result - the Eurozone crisis - High levels of public debt for Eurozone members compared to the US states US debt is mainly federal - the Fed is LOLR to federal government · Without a central bank being a LOLR to government, a country is prone to sovereign debt crisis · However, Eurozone countries have proposed other solutions such as a banking union · Will a banking union without a fiscal union solve the vulnerability of member countries to a sovereign debt crisis in the Eurozone - This is assignment!
What are the origins of the federal reserve system
· Resistance to establishment of a central bank
- Fear of centralised power
- Distrust of moneyed interests
· No lender of last resort
- Nationwide bank panics on a regular basis
- Panic of 1907 so severe that the public was convinced a central bank was needed
· Federal Reserve act of 1913
- Elaborate system of checks and balances
- Decentralised
What was the entities of the federal reserve?
- The federal reserve banks
- The board of governors of the federal reserve system
- The federal Open Market Committee (FOMC)
- The federal Advisory Council
- Around 2,900 member commercial bank
What do the board of governors do?
· Seven members headquartered in Washington DC
· Appointed by the president and confirmed by the senate
· 14 year non-renewable term
· Required to come from different districts
Chairman is chose from the governors and serves four year term
what are the duties of the board of governors?
· Votes on conduct of open market operations
· Sets reserve requirements
· Controls the discount rate through ‘review and determination’ process
· Sets margin requirements
· Sets salaries of president and officers of each federal reserve bank and reviews each banks budget
· Approves bank mergers and applications for new activities
· Specifies the permissible activities of bank holding companies
Supervises the activities of foreign banks operating in the United States
what do the Federal open market committee do (FOMC)
· Meets eight times a year
· Consists of seven members of the board of governors, the president of the federal reserve bank of New York and the presidents of four other reserve banks
· Chairman of the board of governors is also chair of FOMC
Issues directives to the trading desk at the federal reserve bank of new york
What happens inside the Fed: the FOMC meeting
· Report by the manager of system open market operations on foreign currency and domestic open market operations and other related issues
· Presentation of boards staff national economic forecast
· Outline of different scenarios for monetary policy forecast
· Presentation of relevant congressional actions
Public announcement about the outcome of the meeting
how are the federal reserve banks run?
· Quasi-public institution owned by private commercial banks in the district that are members of the fed system
· Member banks elect six directors for each district; three more are appointed by the board of directors - Three A directors are professional bankers - Three B directions are prominent leaders from industry, labour, agriculture, or consumer sector - Three C directors appointed by the board of governors are not allowed to be officers, employees or stockholders of banks - Designed to reflect all constituencies of the public Nine directors appoint the president of the bank; subject to approval by board of governors
What are the functions of the federal reserve banks
· Clear checks
· Issue new currency
· Withdraw damaged currency from circulation
· Administer and make discount loans to banks in their districts
· Evaluate proposed mergers and applications for banks to expand their activities
· Act as liaisons between the business community and the Federal reserve system
· Examine bank holding companies and state chartered member banks
· Collect data on local business conditions
Use staffs of professional economists to research topics related to conduct of monetary policy
Federal Reserve Banks and monetary policy
· Directors establish the discount rate
· Decide which banks can obtain discount loans
· Directors select one commercial banker from each district to serve on the federal Advisory Council which consults with the board of governors and provides information to help conduct monetary policy
Five of the 12 bank presidents have a vote I federal open market committee (FOMC)
