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Central bank 2

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Central bank 2

  1. 1. CHAPTER5 Monetary Policy & Central Bank
  2. 2. Central Bank of Bangladesh:The most important players in financial markets throughout theworld are Central Banks- the Government authorities in charge ofmonetary policy.Central Banks’ action affect 1. Interest rate, 2. the amount of credit, 3. and the money supply, all of which effect on Financial Market as well as on aggregate output and inflation
  3. 3. Central Bank of Bangladesh:•After the liberation war, and the eventual independence of Bangladesh, theGovernment of Bangladesh reorganized the Dhaka branch of the State Bank ofPakistan as the central bank of the country, and named it Bangladesh Bank.•This reorganization was done pursuant to Bangladesh Bank Order, 1972, andthe Bangladesh Bank came into existence with retrospective effect from 16December 1971.•At present it has nine offices located at Motijheel, Sadarghat, Chittagong,Khulna, Bogra, Rajshahi, Sylhet, Barisal and Rangpur in Bangladesh; totalmanpower stood at 5071 (officials 3914, subordinate staff 1157) as of end FY2010.
  4. 4. Central Bank of Bangladesh:Functions:The major functional areas include : Formulation and implementation ofmonetary and credit policies.•Regulation and supervision of banks and non-bank financial institutions,promotion and development of domestic financial markets. “Lender of theLast Resort”.•Management of the countrys international reserves.•Issuance of currency notes- like most of the central banks of differentcountries, exercising monopoly over the issue of currency and the banknotes.Except for the 1 and 2 taka notes, it issues all other denominations ofBangladeshi Taka.•Regulation and supervision of the payment system.
  5. 5. Central Bank of Bangladesh:Functions:4.Acting as banker to the government -6.Money Laundering Prevention.8.Collection and furnishing of credit information.10.Implementation of the Foreign exchange regulation Act.12.Managing a Deposit Insurance Scheme .
  6. 6. Central Bank of Bangladesh:Objectives:3.Formulating monetary and credit policies;4.Managing currency issue and regulating payment system;5.Managing foreign exchange reserves and regulating the foreign exchangemarket;6.Regulating and supervising banks and financial institutions, and advising thegovernment on interactions and impacts of fiscal, monetary and other economic policies.
  7. 7. Central Bank of Bangladesh:Objectives:3.Formulating monetary and credit policies;4.Managing currency issue and regulating payment system;5.Managing foreign exchange reserves and regulating the foreign exchangemarket;6.Regulating and supervising banks and financial institutions, and advising thegovernment on interactions and impacts of fiscal, monetary and other economic policies.
  8. 8. Central Bank of Bangladesh and Monetary policy:Monetary Policythe policy adopted by the central bank for control of the supply of money as aninstrument for achieving the objectives of general economic policy.Monetary Policy refers to all those policy guidelines and supportive moneysupply related mechanism that are used by the central banks to maintain moneysupply at desired volume so that level of a country’s economic activities remainpacified.
  9. 9. Money Generally Money is any accepted means of payment for delivery of goods, receipt of services and settlement of debt. Functions of Money: – A means of payment for goods and services and settlement of debt. – Unit of measurement of value and basis of pricing goods and services. – Store of value over time, but subject to inflation erosion. – Means of deferred payments.
  10. 10. Moneys Characteristics of s Functions of Money Money q Portability q Medium of q Divisibility Exchange q Durability q Store of Value q Stability q Unit of Account
  11. 11. Monetary Aggregatess Narrow definitions of money include items that can be spend directly (cash, current accounts).s Broad definitions of money include items that cannot be spent directly but can be readily converted into cash.
  12. 12. Monetary Aggregates1. Monetary Base: Currency in circulation  Currency and coins plus total reserves2. M1 Money Supply  Currency plus demand deposits3. M2 Money Supply  M1 plus short-term time deposits4. M3 Money Supply  M2 plus long-term time deposits
  13. 13. General versus Selective Credit Controlss General credit controls affect the entire banking and financial system. Examples: reserve requirements, the discount rate, open market operationss Selective credit controls affect specific groups or sectors of the financial system. Examples: moral suasion, margin requirements on the purchase of listed securities
  14. 14. Instruments of monetary policy: s Open market operations: interest rates monetary base s Reserve requirements s Discount window lending
  15. 15. Instruments of monetary policy: s Open market operations: A relatively fine tool that can be used to make small adjustments. These adjustments can be daily and often occur without much fanfare. s Targeted Interest Rates q A relatively blunt tool that can be used to make large adjustments. In typical years, changes in targeted interest rates a few times per year. s Reserve Ratio q A rather blunt tool that is only used when very large adjustments are in order.
  16. 16. Open Market Operationss Buying Treasury securities:  When the Central Bank purchases securities through the government securities dealers,  the account balances of the dealers are credited with the amount  the total amount of fund at the dealer’s bank increases  Increased money supply. Securities Dealer Central Central Bank buys bank Reserves Dealer’s securities bank
  17. 17. Open Market Operationss Selling Treasury securities  When the Central Bank sells securities (obtained from previous purchases) to the government securities dealers,  the account balances of the dealers are debited with the amount  the total amount of fund at the dealer’s bank reduces by the market value of the securities  Reduced money supply growth. Securities Dealer Central Central Bank buys bank Reserves Dealer’s securities bank
  18. 18. Types of Central Bank Open Market Transactions RP or Reverse RP Transaction (temporary change in the level of reserves held by depository institutions) RP: Central Bank buys Reverse RP: Central Bank sells securities temporarily securities temporarily Securities Dealer Securities DealerCentral Central bank Reserves Dealer’s bank Reserves Dealer’s bank bank Later on: Later on: Reserves Reserves Securities returned Securities returned
  19. 19. Reserve Requirements When a bank takes a deposit into an account on which a check can be written, it must place a percentage of that deposit on reserve at a Federal Reserve bank. That percentage is called the reserve ratio.s RR raised - banks reduce lendings RR lowered - banks increase lending
  20. 20. Reserve Requirementss An increase in deposit reserve requirements  decreases the deposit and money multipliers, slowing the growth of money, deposits and loans  reduces the amount of excess legal reserves - institutions deficient in required legal reserves will have to sell securities, cut back on loans, or borrow reserves  increases interest rates, particularly in the money market, as depository institutions scramble to cover any reserve deficiencies
  21. 21. The Discount Rates The discount rate is the annual percentage interest charge levied against those institutions choosing to borrow reserves from the discount window of the Central Bank.s Frequent borrowing is discouraged and may be penalized with a higher interest rate.
  22. 22. The Discount Rates An increase in the discount rate  reduces the volume of loans from the discount window (cost effect)  makes borrowing from the Fed less attractive (substitution effect)  signals that the Fed is pushing for tighter credit conditions (announcement effect), and market participants may respond by curtailing their spending plans or by accelerating their borrowings (to secure the credit they need before interest rates move even higher - negative psychological effect)
  23. 23. Monetary Policys If the Central Bank wants to expand the economy it can q buy bonds q decrease the Discount Rate q lower the reserve ratio. q This increases the supply of loanable funds. This lowers interest rates which increases aggregate demand.s If the central bank wants to contract the economy it can q sell bonds q increase the Discount Rate q raise the reserve ratio. q This decreases the supply of loanable funds. This raises interest rates which decreases aggregate demand.

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