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LECTURE 4 NOTES OVERVIEW OF THE LECTURE: --GENERAL RESPONSIBILITIES OF CENTRAL BANKS --FINANCIAL STABILITY --BALANCE SHEET OF A CENTRAL BANK --CHARACTERISTICS OF A SUCCESSFUL CENTRAL BANK -- STRUCTURE OF THE FEDERAL RESERVE SYSTEM --SPECIFIC MONETARY POLICY TOOLS USED BY THE FEDERAL RESERVE --EFFECTS OF MONETARY TOOLS ON KEY ECONOMIC VARIABLES GENERAL RESPONSIBILITIES OF CENTRAL BANKS --A modern central bank not only manages the gov’t’s finances but also provides an array of services to commercial banks. (It’s both the gov’t’s and bankers’ bank.) Central Banks’ Responsibilities as the gov’t’s bank : 1) In the old times, central banks had to finance wars. 2) Now, they are mainly responsible from stabilizing the country’s economic and financial system. 3) Central banks also control the availability of money and credit in a country’s economy. (Central banks have a monopoly on the issuance of currency. They also use the monetary policy tools to this end, e.g. adjusting the discount rate, using open market operations, or changing the reserve requirements.) Central Banks’ Responsibilities as the bankers’ bank : --Banks as well as the Treasury of a country hold deposits at the central bank. 1) Central banks provide loans to banks during times of financial stress. Lender of last resort function: Central banks can lend cash to banks that will otherwise collapse. This function makes the whole financial system more stable. (New: 1
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Congressional power to audit and disclose loans, Restrict ability to make emergency loans) 2) Central banks manage and secure an efficient payments system. Financial institutions need a cheap and reliable way to transfer funds to one another (interbank payments system). Central banks make sure of the efficient functioning of the interbank payments system. 3) Central banks oversee commercial banks and the financial system. Central banks act as an intermediary insuring that all banks’ commitments are valued at par: $100 bank note from a particular Philadelphia bank is worth the same in NY. Some authority (with no conflict of interest) has to watch over private banks and nonbank financial institutions so that savers and investors can be confident of the system. Central banks take this responsibility. Central banks also deal with sensitive information on lending and credit decisions. That’s also a great responsibility for central banks. What kind of activities are not the responsibilities of Central Banks? 1) Central bank does not control securities markets . It may monitor and participate in bond and stock markets. 2) Central bank does not control the gov’t’s budget . The budget is determined by Congress and the president through fiscal policy. U.S. Treasury then collects the funds through taxes and writes checks to pay gov’t’s
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