Money & banking lecture nine (mansoura university)

ALMOATASSEM MOSTAFA

LECTURE NINE: 2 DECEMBER 2016

Money & Banking

Functions of Central Bank

Functions of

Central Banks

Issuing Currenc

y

Banker to the

government

Banker to commercial banks

Conducting

monetary policy

Banker to the Government

A central bank is the major banker to governments. Governments in this context refer to central governments since central banks do not bank with provincial governments الريفية or الحكوماتlocal authorities.


The Exchequer Account

The Paymaster

General Account


In some cases, Central Banks hold an account called Tax and Loan Account (TT&L) in large commercial banks; this account does the job of both the Exchequer Account and the Paymaster General Account.

A Tax and Loan Account incorporates both funds received by the government (taxes) and funds to be spent by the government (salaries).


Since the central bank is the sole banker to the government, the funds received at the Exchequer Account are mainly funds lost by the private banking sector, while funds to be spent by the government from the Paymaster General Account are mainly funds gained by the private banking sector.


Exchequer Account

Taxes including, income,

corporate, and value-added

taxes

Customs and Sales of

Government Securities

Paymaster General Account

Maturities and interest on government securities

Salaries, social security and

pensions, and purchase of goods and services

Banker to Commercial Banks

Required Reserves Account

Settlement Account


In some cases, commercial hold one account that comprises both required reserves and funds allocated for settlement of interbank operations.

Generally, commercial banks tend to stick to the minimum required funds at the Required Reserves Account because they do not receive interest on this account from the Central Bank.


In addition, in exceptional circumstances, especially when the economy is not performing efficiently, a central bank might require commercial banks to hold the required reserves for extended periods.

This strategy is adopted by central banks in order to keep interest rates at minimum to catalyze the economy to perform efficiently.

This strategy additionally encourages commercial banks to grant more loans and create credit through deposits


Interest rates play a central role the economy. They are the cost of borrowing and the reward for lending. Higher rates restrict growth of credit.

For example, with a 10% reserve requirement on net transaction accounts, a bank that experiences a net increase of $200 million in these deposits would be required to increase its required reserves by $20 million.

The bank would be able to lend the remaining $180 million of deposits, resulting in an increase in bank credit. As those funds are lent, they create additional deposits in the banking system. The increase in deposits affects the money stock,


commercial banks are required to hold more cash on hand and are less able to increase the amount of loans to give consumers and businesses. This reduces the money supply, economic growth, and increases interest rates.

commercial banks are required to hold less cash on hand and are able to increase the amount of loans to give consumers and businesses. This increases the money supply, economic growth, and reduces interest rates.

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Req

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A central bank additionally represents lender of the last resort for commercial banks.

Loans offered from central banks to commercial banks are called discount loans.

Central banks may force commercial banks to borrow from them as a part of the monetary policy they conduct and in order to balance their assets and liabilities.

Conducting Monetary Policy


Monetary policy is the process by which central banks adjust interest rates through influencing the supply of money in order to restrict inflation and achieve price stability.


This is what the macroeconomic function of the central bank is all about; influencing a number of macroeconomic variables, such as money supply and interest rate, to limit inflation within moderate rates.


But why central banks always try to limit inflation to certain rates?


Inflation is an ongoing increase in the general level of prices of goods and services.

Inflation rate is measured by a certain annual percentage.

Inflation reduces the purchasing power of money in which every pound purchases less goods and services.

The value of currency keeps declining as a result of inflation and its purchasing power declines accordingly.





We highlight Demand-Pull Inflation. This kind of inflation is caused by the existence of too much money in the economy (increased money supply). A solution to address inflation is to absorb money from the market by reducing money supply.


Price stability is, therefore, the core of monetary policy. A central bank targets price stability through contracting and expanding its assets. This would influence both money supply and interest rate, and would therefore influence the level of prices.

Monetary policy is either expansionary توسعية or contractionary انكماشية. Expansionary monetary policy targets increasing money supply in the economy, while the contractionary one targets decreasing money supply.



One of the main tools of monetary policy is what is called Open Market Operations.

Open Market Operations refer to the operations by which the central bank buys or sells government securities, including treasury bills and bonds, in the open market. These operations either inject or absorb liquidity into or from the economy, and they therefore influence inflation rate.

Open Market Operations

Open Market Operations

Contractionary Policy: Sale of government securities less money

supplyand absorption of money from market higher interest less borrowing and less credit creation

Expansionary Policy: Purchase of government securities more

money supply and injection of money to market higher interest more borrowing and more credit creation

Why Price Stability?

Price stability is an indicator that the economy is performing well and efficiently.

Price stability implies the absence of inflation and deflation.

This results in preserving the purchasing power of money for an extended period.

The existence of price spikes, in contrast, is harmful to consumers, producers, and to the economy as a whole. These spikes result in a sustained decline in the purchasing power of money.

Advantages of Price Stability

Higher standard of

living (stability of purchasing

power)

Reduces the

uncertainty associated with price changes

Reduces the

distortionary effects of the taxing

Guarantees equitable

distribution of income

and wealth,

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Money & banking lecture nine (mansoura university)

Economy & Finance