Central banks are often charged with • supervising the nation’s banking system. • regulating and overseeing the payments system. • managing a nation’s foreign currency and gold reserves. • operating a nation’s monetary policy. Often, the objective of the central bank is the stability of the financial system and management of the payments system. COPYRIGHT © 2014 CFA INSTITUTE 57
Federal Reserve Dual Mandate The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates.  The first two objectives are sometimes referred to as the Federal Reserve's dual mandate.  Its duties have expanded over the years, and as of 2009 also include supervising and regulating banks , maintaining the stability of the financial system and providing financial services to depository institutions , the U.S. government, and foreign official institutions.  The Fed conducts research into the economy and provides numerous publications, such as the Beige Book and the FRED database . 58
Monetary policy tools 1. Open market operations • Open market operations are the purchases and sales of government bonds from and to commercial banks or market makers. 2. Changing the policy rate • Establishing a policy rate (official policy rate or interest rate) that influences other rates in the economy. ◦ Repurchase rate (repo rate) is the rate at which the central bank agrees to buy or sell bonds to commercial banks through a repurchase agreement . ◦ In the United States, ◦ the discount rate is the rate at which member banks borrow from the central bank. ◦ the federal funds rate is the rate on interbank lending on overnight borrowing or reserves. 3. Changing the reserve requirements • A reserve requirement is a requirement by the central bank that banks keep a specified percentage of their deposits on hand, which thus affects the supply of money. COPYRIGHT © 2014 CFA INSTITUTE 59
Policies of the Central bank Inflation targeting • Central banks are often involved in price-level stability. ◦ Unexpected inflation is costly because it is not factored into wage negotiations and contracts, and the uncertainty regarding inflation can affect (and exacerbate) the business cycle. ◦ Inflation targeting is the maintenance of price stability using monetary policy. ◦ Common target: 2% based on the CPI • In developing nations, there are challenges to price stability (e.g., illiquid government bond market, changing economy, changing definition of money supply, and lack of credibility). Exchange rate targeting is used by some countries. • Exchange rate targeting requires setting a band for the target exchange rate against a major currency.
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