6 In todays world central banks use monetary policy to stabilize economic

6 in todays world central banks use monetary policy

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6. In today’s world, central banks use monetary policy to stabilize economic growth and inflation. 7. An expansionary or accommodative policy (lower interest rates) raises growth and inflation; tighter or restrictive policy reduces them. Instructor’s Manual t/a Cecchetti: Money, Banking, and Financial Markets 213
Chapter 15 Central Banks in the World Today 8. Governments want to control the printing of paper money because it is a very profitable business; also, losing control of the amount of currency means losing control of inflation. 2. The Bankers' Bank 1. The most important day-to-day jobs of the central bank are to: a. provide loans during times of financial stress (the lender of last resort). a. manage the payments system (settles interbank payments). b. oversee commercial banks and the financial system (handles the sensitive information about institutions without conflicts of interest). 2. By ensuring that sound banks and financial intermediaries can continue to operate, the central bank makes the whole financial system more stable. 3. Central banks are the biggest and most powerful players in a country’s financial and economic system and are supposed to use this power to stabilize the economy, making us all better off. 4. However, central banks that are under extreme political pressure, or that are simply incompetent, can wreak havoc on the economic and financial systems. 5. A central bank does not: b. control securities markets. a. control the government’s budget. 6. The common arrangement today is for the central bank to serve the government in the same way that a commercial bank serves a business or an individual. III.Stability: The Primary Objective of All Central Banks 1. When left on their own economic and financial systems are prone to episodes of extreme volatility; central bankers work to reduce that volatility. 2. Central bankers pursue five specific objectives: a. low and stable inflation b. high and stable real growth, together with high employment c. stable financial markets and institutions d. stable interest rates e. a stable exchange rate 3. Instability in any of those would pose an economy-wide economic risk that diversification could not mitigate. Thus the job of the central bank is to improve general economic welfare by managing and reducing systematic risk. 4. It is probably impossible to achieve all five of these objectives simultaneously, and so tradeoffs must be made. A. Low, Stable Inflation 1. Many central banks take as their primary job the maintenance of price stability; they strive to eliminate inflation. 2. The rationale for keeping the economy inflation-free is that money’s usefulness as a unit of account and as a store of value is enhanced when its purchasing power is maintained. 3. Inflation degrades the information content of prices and impedes the market’s function of allocating resources to their best uses.

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