CH7 - Chapter 15 Central Banks in the World Today Chapter...

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Chapter 15 Central Banks in the World Today Chapter Overview Despite the constant presence of central banks in the news and their unprecedented power, most people only have a vague idea of what they are and what they do. The purpose of this chapter is to explain the role of modern central banks in our economic and financial system and to examine the complexities policymakers face in meeting their responsibilities. Reading this chapter will prepare students to: Understand the functions of a modern central bank; Explain the specific goals of a central bank; Define the characteristics of the best central banks and use them in assessment of a central bank; and Analyze how fiscal policy can interfere with a central bank’s efforts. Important Points of the Chapter The Federal Reserve is the United States’ central bank, which has the responsibility of making sure that our financial system functions smoothly. Central banks act during times of crisis, but their work is also vital to the day-to-day operation of any modern economy. Application of Core Principles Principle #5: Stability (page 356) When economic and financial systems are left on their own they are prone to episodes of extreme volatility; central bankers work to reduce that volatility by pursuing the objectives of: low and stable inflation; high and stable real growth, together with high employment; stable financial markets; stable interest rates; and a stable exchange rate. Principle #2: Risk (page 357) Inflation creates risk, and the higher it is the greater the risk. Unpredictable inflation makes bonds risky because it affects the real return a bondholder receives. Since the risk has increased, so must the compensation, and thus inflation risk drives up the interest rate required to entice investors to hold bonds. Principle #2: Risk (page 359) Central bankers work to moderate fluctuations in general business conditions because they are the primary source of systematic risk. Principle #5: Stability (page 361) The objectives of a modern central bank are all about stability, in inflation, growth, the financial system, interest rates and exchange rates. 209 Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets
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Chapter 15 Central Banks in the World Today Principle #3: Information (page 365) Central bank statements are very different today than they were at the beginning of the 1990s, because secrecy is now understood to damage both the policymakers and the economies they are trying to manage. Teaching Tips/Student Stumbling Blocks If you have the equipment to do so, one of the most effective ways to begin the material in this chapter is to visit the web site of the Bank for International Settlements. In particular, a list of central banks and links to their web pages can be found at This certainly reinforces the point about how many countries have central banks. An interesting assignment might be to have students pick different countries and write a
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CH7 - Chapter 15 Central Banks in the World Today Chapter...

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