1. SB_FDI_EM
Prof. Dr. John JA Burke
CENTRAL BANKS

2. Major Activities
 Supervision of banking system
 Often not true
 Monetary Policy
 Printing of notes and coins
 Banker to other banks
 Banker to government
 Raising money for government
 Controlling nation’s official reserves
 Lender of last resort
 International liaison

3. Government Bank
 Central banks historically were bankers to governments
 Governments have financial needs of their own
 Central bank occupies privileged position
 It has monopoly over the money supply
 It controls the printing press
 Central bank can control money in supply of economy
 Activity of adjusting money supply is called “monetary
policy”

4. Monetary Policy
 Modern function
 Stabilise economic growth
 Control inflation
 Expansionary policy
 Lower interest rates
 Raises both growth and inflation
 Puts more money into system
 Restrictive Policy
 Raise interest rates
 Reduce money supply
 Contraction

5. Primary Reason to Create Central
Bank
 Ensure control over currency
 E.g., Collapse of Soviet Union
 Central Bank of Russia controlled the money supply
 Inflation rate in 1992 in ruble zone reached 1000%
per year
 Result
 Monetary system collapsed

6. Bankers’ bank
 Guarantees that sound banks can do business
by lending to them, especially in crises
 Operate a payment system for interbank
payments
 Oversee financial institutions to ensure
confidence
 As stated, Consolidated Financial Regulator now
performs this service
 Lender of last resort
 Avoid runs on bank deposits

7. Objectives
 Low stable inflation
 Inflation creates confusion and makes planning difficult
 High inflation/low growth
 High Stable Growth
 Stable, predictable growth
 Financial system stability
 Necessity for economy to run efficiently
 Stable interest rates
 Interest rate volatility creates risks for lenders and borrowers
 Stable exchange rates
 Variable exchange rates make revenues from foreign sales and
cost of purchasing imported goods/services hard to predict

8. Central Bank Design
 Independence
 To keep inflation law, monetary policy must be free
from political influence
 Decision making by committee
 Pooling knowledge yields better decisions
 Accountability and Transparency
 Held accountable to public
 Communicate objectives
 Policy framework
 Clearly state policy and identify trade-offs

9. European Central Bank
 Created in 1998 by Protocol entitled [But Treaty of Lisbon has amended
Provisions]
 Statute of the European System of Central Banks and of the European
Central Bank
 Design
 ECB in Frankfurt oversees monetary policy
 National Central Banks [NCBs] that belong to EU are members, but not
all equal
 ESCB
 Eurosystem
 ECB plus NCBs that have EURO
 ECB Executive Board
 6 member body that implements policy
 Governing Council
 16 member committee that makes monetary policy for common
currency area

10. ECB: Treaty of Lisbon
 Article 282 establishes the European Central
Bank and the ESCB
 Monetary Policy provisions are set forth in
Articles 127 to 133 and 138
 Article 283
 Governing Council
 Executive Board [Six members]
 Governors of NCBs that have EU
 European Council appoints members of the Executive
Board – Term of office 8 years not renewable

11. ECB: Treaty of Lisbon
 Protocol Nr. 4 of the Treaty sets forth ESCB
Statute
 Primary objective is price stability
 Basic tasks
 Define and implement monetary policy for EU
 Conduct foreign exchange operations
 Hold and manage official reserves of Member
States
 Promote operation of payment systems

12. ECB: Treaty of Lisbon
 Article 7 of Protocol
 ECB is totally independent from EU government
institutions
 Has legal personality
 Minimum capital 5,000 million EURO [Art. 28]

13. ECB: Treaty of Lisbon
 Article 18
 Open Market and Credit Operations
 Buy and sell [spot and forward] outright or under
repurchase agreements
 Lending and borrowing claims and marketable
instruments in EURO or other countries
 Conduct credit operations with credit institutions
and other market participants with lending backed
by collateral

14. Treaty of Lisbon
 Article 19
 ECB may require all credit institutions established
in the Member States to hold minimum reserves
with the ECB and NCBs

15. Fundamental Tools
 Regulate interest rates through money supply
 Reserve requirements
 Lending to banks
 Open market operations

16. Negatively Sloped Money Demand Curve
IR
Money

17. Equilibrium Interest Rate
MS MS1
R1
R~
MD
M M1

18. Demand for Money
 Transaction demand
 Day to day needs
 IR of no effect
 Precautionary demand
 Unanticipated payments
 Affects real GDP
 Speculative demand
 Holding money in belief interest rates will rise