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CH8 - Chapter 17 The Central Bank Balance Sheet and the...

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Chapter 17 The Central Bank Balance Sheet and the Money Supply Process Chapter Overview In this chapter we develop an understanding of how the central bank interacts with the financial system and how its balance sheet is connected to the money and credit that flows through the economy. Reading this chapter will prepare students to: Understand and interpret the balance sheet of a central bank; Explain the money multiplier and the creation of money process; and Analyze how a central bank can use its balance sheet in conducting monetary policy. Important Points of the Chapter One of the great successes of modern central banking is the story of the U.S. Federal Reserve on September 11. Because of its quick action, the Fed kept the financial markets afloat, and the financial system returned to near normal within weeks. This is a marked contrast to what happened in the 1930’s, and the difference is that in the 30’s Fed officials failed to provide the liquidity that sound banks needed to stay in business. In 2001, the statement that came from the Fed was: “The Federal Reserve is open and operating. The discount window is available to meet liquidity needs.” Application of Core Principles Principle #3: Information (page 404) The balance sheet published by the central bank is probably the most important information that it makes public. Principle #4: Time (page 412) If a bank sells an interest-bearing U.S. Treasury bond to the Fed and receives reserves it will want to lend those reserves because holding them for any period of time means foregoing interest income (reserves are noninterest-bearing). Teaching Tips/Student Stumbling Blocks Students will likely have difficulty understanding the impact of different transactions on the central bank’s balance sheet. Emphasize the rule from page 433: When the value of an asset on the balance sheet increases, either the value of another asset decreases (so the net change is zero) or the value of a liability rises by the same amount (and similarly for an increase in liabilities). Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets 239
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Chapter 17 The Central Bank Balance Sheet and the Money Supply Process Features in this Chapter Applying the Concept : Central Bank Balance Sheets (page 402) Comparing the balance sheets of the Federal Reserve System, the Eurosystem, and the People’s Bank of China reveal some interesting differences. The Eurosystem, for example, has much higher foreign exchange reserves than the Fed, as well as larger gold holdings. The ECB also has much larger holdings of commercial bank reserves than the Fed; that’s because it pays interest on such reserve holdings while the Fed does not. The enormous foreign exchange reserves and loans of the PBOC reflect the country’s policy of keeping the value of its currency fixed. Unlike the ECB or the Fed, the PBOC balance sheet also shows loans which are in reality subsidies to keep state-owned companies afloat.
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