The document outlines the major duties and functions of central banks, including conducting monetary policy, supervising financial institutions, and maintaining financial stability. It describes the tools that central banks use to implement monetary policy, such as open market operations, reserve requirements, and the discount rate. The goals of monetary policy are also discussed, including price stability, economic growth, and maintaining stable interest and exchange rates.

1. Major Duties and Responsibilities
of Central Bank
 Conducting monetary policy
 Supervising and regulating depository
institutions
 Maintaining the stability of the financial
system
 Providing payment and other financial
services to the government, the public, FIs
and foreign official institutions
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2. Functions Performed by the Central Banks
 Assistance in the Conduct of Monetary
Policy
 Supervision and Regulation
 Government Services
 New Currency Issue
 Check Clearing
 Wire Transfer Services
 Research Services
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3. Place of Central Bank in the Monetary System
Central Bank
Federal Reserve Sytem
Facilitates transfer of
Defines and regulates money through check
Lender of last Resort
money supply processing/clearing
Banking System:
1. Creates money
2. Transfers money
3. Provides financial intermediation
4. Processes/clears checks
First
Bank
Other Last
Banks Bank
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4. Balance Sheet of the Federal Reserve
(in billions of dollars, 2002)
Assets Liabilities and Equity
Gold and foreign exchange $ 25.5 Depository institution reserves $ 17.5
SDR certificates 2.2 Vault cash of commercial banks 47.3
Treasury currency 33.2 Deposits due to federal government 7.1
Federal Reserve Float 0.0 Deposits due to rest of the world 0.1
FR loans to domestic banks 0.0 Currency outside banks 596.2
Security repurchase agreements 50.3 Miscellaneous liabilities 7.8
U.S. Treasury securities 551..7 FR Bank stock 7.2
U.S. government securities 0.0
Miscellaneous assets 20.3
Total assets $683.2 Total liabilities and equity $683.2
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5. Objective of Monetary Policy
 To influence the amount of reserve in the
banking system…
 which affects interest rates and
availability of credit and…
 ultimately affects the levels of
employment, output, prices and inflation
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6. Money Stock
 There are a number of measures of a
nation’s money stock (M).
 The narrowest measure is the sum of
currency in circulation and the amount of
transactions deposits (TD) in the banking
system.
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7. Money Multiplier
 Most nations require that a fraction of
transactions deposits be held as reserves.
 The required fraction is determined by the
reserve requirement (rr).
 This fraction determines the maximum
change in the money stock that can result
from a change in total reserves.
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8. Money Multiplier
 Under the assumption that the monetary
base is comprised of transactions deposits
only, the multiplier is determined by the
reserve requirement only.
 In this case, the money multiplier (m) is
equal to 1 divided by the reserve
requirement,
 m = 1/rr.
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9. Relating the Monetary Base and the Money Stock
 Under the assumptions above, we can
write the money stock as the monetary
base times the money multiplier.
M = m•MB = m(C + TR).
 The change in the money stock is
expressed as
∆M = m(∆C + ∆TR).
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10. Example - BOJ Intervention
 Suppose the Bank of Japan (BOJ)
intervenes to strengthen the yen by selling
¥1 million of US dollar reserves to the
private banking system.
 This action reduces the foreign exchange
reserves and total reserves component of
the BOJ’s balance sheet.
10

11. BOJ Balance Sheet
Assets Liabilities
FER TR
-¥1 -¥1 million
million
Result: R ¥1 million, MB ¥1 million
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12. BOJ Intervention
 Because the monetary base declined, so
will the money stock.
 Suppose the reserve requirement is 10
percent. The change in the money stock
is
∆M = m(∆DC + ∆FER),
∆M = (1/.10)(-¥1 million) = -¥10 million.
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13. Monetary Policy Tools
 Open Market Operations
 primary determinate of changes in excess
reserves in the banking system impacting the size
of the money supply and/or interest rates
 The Discount Rate
 the rate of interest Central Bank charge on
emergency loans to depository institutions
 Reserve Requirements
 determine the minimum amount of reserve assets that
depository institutions must maintain by law to back
transaction deposits held as liabilities
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14. Tools of Monetary Policy
Open Market Operations
 To change Reserves
 To offset other factors affecting Reserves
 Typically uses repos & reverse repos: Open market
transactions to purchase gov. Securities with an
aggrement that seller will repurchase them in a
predetermined time period.
Advantages of Open Market Operations
 1. Central Bank has complete control
 2. Flexible and precise
 3. Easily reversed
 4. Implemented quickly
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15. Open Market Operations
 Monetary Base = Currency + Reserves
 Open Market Purchase from Bank
The Banking System The Fed
Assets Liabilities Assets Liabilities
Securities Securities Reserves
- $100 + $100 +$100
Reserves
+ $100
Result: R ↑ $100, MB ↑ $100
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16. Open Market Operations
Open Market Purchase from Public
Public The Fed
Assets Liabilities Assets Liabilities
Securities Securities Reserves
- $100 + $100 +$100
Deposits
+ $100
Banking System
Assets Liabilities
Reserves Deposits
+ $100 + $100 Result: R ↑ $100, MB ↑ $100
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17. Discount Rate
The rate on loans to depository instituions
 Ambiguous effect on money supply
 Signalling function: used to send a
message to financial markets
Lender of Last Resort Function
1. To prevent banking panics
2. To prevent non-bank financial panics
 Moral Hazard Problem
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18. Discount Loans
Banking System The Fed
Assets Liabilities Assets Liabilities
Reserves Discount Discount Reserves
+ $100 loan + $100 loan + $100 + $100
Result: R ↑ $100, MB ↑ $100
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19. Reserve Requirements
 Advantages
 1. Powerful effect on money supply
 Disadvantages
 1. Small changes have very large effect on MS
 2. Raising reserve requirement ratio causes
liquidity problems for banks
 3. Frequent changes cause uncertainty for
banks
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20. Goals of Monetary Policy
Goals
1. Price Stability
2. High Employment
3. Economic Growth
4. Interest Rate Stability
5. Financial Market Stability
6. Foreign Exchange Market Stability
 Goals often in conflict
“The primary objective of the Bank shall be to achieve and
maintain price stability.”
Cental Bank of the Republic of Turkey
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21. A. Price Stability
 Unanticipated inflation leads to lender losses. Nominal contracts attempt to
account for inflation.
 Effort successful if monetary policy able to maintain steady rate of inflation.
B. High Employment
 The movement of workers between jobs is referred to as frictional
unemployment.
 All unemployment beyond frictional unemployment is classified as unintended
unemployment. Reduction in this area is the target of macroeconomic policy.
C. Economic Growth
 Economic growth is enhanced by investment in technological advances in
production.
 Encouragement of savings supplies funds that can be drawn upon for
investment.
D. Interest Rate and Exchange Rate Stability
 Volatile interest and exchange rates generate costs to lenders and borrowers.
Unexpected changes that cause damage, making policy formulation difficult.
E. Conflicts Among Goals
 Goals frequently cannot be separated from each other and often conflict.
Costs must therefore be carefully weighed before policy implementation.
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22. Impact of Monetary Policy
on Various Economic Variables
Expansionary Contractionary
Activities Activities
Impact on
Reserves
Credit availability
Money supply
Interest rates
Security prices
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23. Alternative Monetary Policies
Interest Interest MS’ MS
Rate Rate
i’=8%
i* = 6%
MD’
i*=6%
i’’= 5% MD
MD’
i’’=4%
MD MD’’
MD’’
MS
Quantity of Money Quantity of Money
(in billions) (in billions)
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24. International Monetary Policies
and Strategies
 Foreign Exchange Intervention
1. Controlled exchange rate regimes
under ERBS Programs
2. To stabilize the unstable FX market
 similar to open market purchases and
sales of Treasury securities
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25. Institutional Framework for a Credible Central
Bank
 Independence
 Accountability
 Transparency
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