Chapter Three The Role of The Central Bank

Central Bank Activities Supervision of the banking system Advising the government on monetary policy Issue of banknotes Acting as banker to the other banks Acting as banker to the government Raising money for the government Controlling the nation’s currency reserves Acting as ‘lender of last resort’ Liaison with international bodies

Monetary Policy The decisions on monetary policy may be taken by the government if the central bank is not independent, or by the central bank itself if it is. In any case, the central bank will cooperate with the government on economic policy generally and will produce advice on monetary policy and economic matters, including all the statistics The independence of central banks has become a topical issue

Banknotes The central bank controls the issue of banknotes and possibly, but not necessarily, coins also. Most payments these days do not involve cash but cheques, standing orders, direct debits, credit cards and so on. Nevertheless, cash is important as banks’ cash holdings are a constraint on the creation of credit.

Bankers to the Other Banks The central bank will act as banker to the other banks in the economy, as well as holding accounts with international bodies like the International Monetary Fund (IMF) and the World Bank It is a common habit for the central bank to insist that the other banks hold non-interest-bearing reserves with it in proportion to their deposits Apart from helping the bank to make a profit, these serve as an instrument of control over the money supply

Bankers to the Government Normally, a central bank acts as the government’s banker. It receives revenues for taxes or other income and pays out money for the government’s expenditure Usually, it will not lend to the government but will help the government to borrow money by the sales of its bills and bonds

Raising Money for the Government While the Treasury or Ministry of Finance sometimes handles government issues, it is much more common for the central bank to control this and to settle payments through the accounts that banks and financial institutions have with it Over time, the debt grows and is not, in any real sense, ever ‘paid off’. Does this matter? The first point is that, for any individual, how serious debt is depends on their income. Inflation is also a key factor Finally, to whom is the money owed?

Acting As Lender of Last Resort Acting as lender of last resort not only refers to the role of the bank as a periodic rescuer of banks in trouble, it also refers to the fact that the central bank will help the other banks temporarily when they meet problems with their liquidity During 2008, the US, the UK and all European central banks and governments engaged in widespread liquidity support schemes in order to support their banking systems

Liaison with International Bodies Central banks will liaise with other international financial bodies like the IMF and the International Bank for Reconstruction and Development (IBRD), usually called the World Bank. They also liaise with and take part in discussions at the Bank for International Settlements (BIS) in Basel Regular meetings between G7, G10 and G20

The Position of Central Bank Today Inflation is the key target for central banks. Questions: 1. How do we measure inflation? 2. Accountability is another current issue. 3. Do we need a central bank?