1. CHAPTER
5 Monetary Policy
&
Central Bank

2. Central Bank of Bangladesh:
The most important players in financial markets throughout the
world are Central Banks- the Government authorities in charge of
monetary 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. Central Bank of Bangladesh:
•After the liberation war, and the eventual independence of Bangladesh, the
Government of Bangladesh reorganized the Dhaka branch of the State Bank of
Pakistan as the central bank of the country, and named it Bangladesh Bank.
•This reorganization was done pursuant to Bangladesh Bank Order, 1972, and
the Bangladesh Bank came into existence with retrospective effect from 16
December 1971.
•At present it has nine offices located at Motijheel, Sadarghat, Chittagong,
Khulna, Bogra, Rajshahi, Sylhet, Barisal and Rangpur in Bangladesh; total
manpower stood at 5071 (officials 3914, subordinate staff 1157) as of end FY
2010.

4. Central Bank of Bangladesh:
Functions:
The major functional areas include : Formulation and implementation of
monetary and credit policies.
•Regulation and supervision of banks and non-bank financial institutions,
promotion and development of domestic financial markets. “Lender of the
Last Resort”.
•Management of the country's international reserves.
•Issuance of currency notes- like most of the central banks of different
countries, exercising monopoly over the issue of currency and the banknotes.
Except for the 1 and 2 taka notes, it issues all other denominations of
Bangladeshi Taka.
•Regulation and supervision of the payment system.

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. 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 exchange
market;
6.Regulating and supervising banks and financial institutions, and advising the
government on interactions and impacts of fiscal, monetary and
other economic policies.

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 exchange
market;
6.Regulating and supervising banks and financial institutions, and advising the
government on interactions and impacts of fiscal, monetary and
other economic policies.

8. Central Bank of Bangladesh and Monetary
policy:
Monetary Policy
the policy adopted by the central bank for control of the supply of money as an
instrument for achieving the objectives of general economic policy.
Monetary Policy refers to all those policy guidelines and supportive money
supply related mechanism that are used by the central banks to maintain money
supply at desired volume so that level of a country’s economic activities remain
pacified.

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. Money
s 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. Monetary Aggregates
s 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. Monetary Aggregates
1. Monetary Base: Currency in circulation
 Currency and coins plus total reserves
2. M1 Money Supply
 Currency plus demand deposits
3. M2 Money Supply
 M1 plus short-term time deposits
4. M3 Money Supply
 M2 plus long-term time deposits

13. General versus Selective Credit Controls
s General credit controls affect the entire
banking and financial system.
Examples: reserve requirements, the discount
rate, open market operations
s Selective credit controls affect specific groups
or sectors of the financial system.
Examples: moral suasion, margin
requirements on the purchase of
listed securities

14. Instruments of monetary policy:
s Open market operations:
interest rates
monetary base
s Reserve requirements
s Discount window lending

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. Open Market Operations
s 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. Open Market Operations
s 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. 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 Dealer
Central Central
bank Reserves Dealer’s bank Reserves Dealer’s
bank bank
Later on: Later on:
Reserves Reserves
Securities returned Securities returned

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 lending
s RR lowered - banks increase lending

20. Reserve Requirements
s 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. The Discount Rate
s 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. The Discount Rate
s 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. Monetary Policy
s 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.