Topic 7: Central Banking

A. TERMS, THEORIES AND DEFINITIONS                             

Theories:

A central bank, reserve bank, or monetary authority is a public institution that usually issues the currency, regulates the money supply, and controls the interest rates in the country. Central banks often also oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on printing, the national currency, which usually serves as the nation’s legal tender. Examples include
the European Central Bank (ECB), the Federal Reserve of the United States, Reserve Bank of India and the People’s Bank of China.

The primary function of a central bank is to provide the nation’s money supply, but more active duties include controlling interest rates, and acting as a lender of last resort to the banking sector during times of financial crisis. It may also have supervisory powers, intended to prevent banks and other financial institutions from reckless or fraudulent behaviour. Central banks in most developed nations are independent in that they operate under rules designed to render them free from political interference.

Activities and responsibilities

  Functions of a central bank may include:

    implementing monetary policy;

    determining interest rates;

    controlling the nation’s entire money supply;

    the Government’s banker and the bankers’ bank (‘lender of last resort’);

    managing the country’s foreign exchange and gold reserves and the Government’s stock register;

    regulating and supervising the banking industry;

    setting the official interest rate – used to manage both inflation and the country’s exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms.

Terms and definitions:

Monetary policy is the process by which the monetary authority of a country controls the supply of money, often targeting a rate of interest for the purpose of promoting economic growth and stability. The official goals usually include relatively stable prices and low unemployment.

Money supply or money stock is the total amount of money available in an economy  at a particular point in time. There are several way to define “money” but standard mesures usually include currency in circulation and demand deposits.

B. VOCABULARY EXERCISES

Match words below with their definitions

1. policy 2. threats 3. oversight 4. target 5. core (adj) 6. sound (adj) 7. sterling 8. inflation 9. remunerated

a. a level or situation which you intend to achieve b. a general, continuous increase in prices c. an agreed plan of what to do d. basic and most important e. in good condition f. paid g. potential sources of danger h. supervision i. the name of the British currency

C. READING

Reading 1:

The Bank of England has two (1)..................... purposes. One is ensuring monetary stability, i.e. having stable prices – low (2)..................... – and consequently confidence in the currency.

The government sets an inflation (3)........................, and the Bank’s Monetary Policy Committee tries to meet it by raising or lowering the official interest rate when necessary.

UK banks and building societies have to hold reserves at the Bank. These are (4)......................at the Bank’s official interest rate. If British banks need to borrow short – term funds they do this in the (5)................... money markets.

The Bank can influence the amount of money and the interest rates in these markets – this is how it implements its monetary (6)........................

The Bank also deals in the foreign exchange market. It can use the UK’s foreign currency and gold reserves to try to influence the exchange rate if needed.

The Bank’s other core purpose is to maintain the stability of the financial system. The Bank has to detect and reduce any (7)................. to financial stability, and make sure the overall system is safe and secure. It monitors and analyses the behaviour of the major participants in the financial system and the wider financial and economic environment, and tries to identify potential risks. A (8).............................and stable financial system is important, and is also necessary for carrying out monetary policy efficiently.

The Bank’s role also includes (9).....................of payment systems for transactions between individuals, businesses and financial institutions.

The Bank sometimes acts as ‘lender of last resort’ to financial institutions in difficulty, to prevent panic or a loss of confidence spreading through the whole financial system.

Exercise 1. Complete the text with the words (1 – 9) from the Vocabualry exercise in section B.

Exercise 2. According to the text, are the following statements true or false?

1. The Bank of England wants to prevent prices rising.

2. The government sets a figure for what it thinks should be the maximum inflation rate.

3. The government makes decisions about interest rates.

4. Commercial banks have to keep some of their funds at the Bank of England.

5. The Bank does not pay interest on commercial banks’ deposits.

6. The Bank can try to change the sterling exchange rate.

7. The Bank has to elimimate threats to financial stability.

8. The Bank supervises the clearing system: the settlement of claims between banks.

9. The Bank always lends money to financial institutions in danger of going bankrupt.

Reading 2:

By alexander davidson

Exercise 3. Answer the following questions:

1. Are the Fed’s policies directly influenced by the US Congress?

2. How many Federal Reserve Banks are there interest rates the US?

3. What are obligations and rights of commercial banks toward the regional Fed bank?

4. How many main monetary policy instruments does the Fed use to control the money supply? What are they? What is the most important instrument?

5. What can the Fed do with government securities if it wants the banking system to have extra reserves?

6. Who issues government securities interest rates the US?

7. What short – term open market operations that were used by the Fed interest rates the credit crisis of 2007 – 2009?

8. What can banks do when they want to increase their reserves?

9. What are reserve requirements?

10. What do people tend to do under the gold standard?

11. Why do some people worry about Fed’s methods in the credit crisis of 2007 – 2009?

12. How did the chairman of the Fed justify these methods?

D. GUIDE

Exercise 1:

(1) core (2) inflation (3) target

(4) remunerated (5) sterling (6) policy

(7) threats (8) sound (9) oversight

Exercise 2.

1	2	3	4	5	6	7	8	9
T	T	F	T	F	T	F	T	F

F. FURTHER STUDY

ECB