Ngân hàng tín dụng - Money and banking (lecture 30)

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved. Money and Banking Lecture 30 15-2 Review of the Previous Lecture • Banking Crisis • Sources of Runs, Panics and Crisis • Government Safety Net • Government as lender of last resort 15-3 Topics under Discussion • Central Bank: • The Government’s Bank • The Bankers’ Bank • Objectives 15-4 www.sbp.org.pk 15-5 The Government's Bank • The central bank started out as the government’s bank, originally created by rulers to finance wars • However, the early examples are really the exceptions, as central banking is largely a 20th century phenomenon. • The central bank occupies a privileged position: it has a monopoly on the issuance of currency 15-6 • The central bank creates money and thereby controls the availability of money and credit in a country’s economy • Most central banks go about this by adjusting short-term interest rates, an activity called monetary policy. • In today’s world, central banks use monetary policy to stabilize economic growth and inflation. 15-7 • An expansionary or accommodative policy (lower interest rates) raises growth and inflation; tighter or restrictive policy reduces them. • Governments want to control the printing of money because it is a very profitable business; also, losing control of the amount of currency means losing control of inflation. 15-8 The Bankers' Bank • The most important day-to-day jobs of the central bank are to: • provide loans during times of financial stress (the lender of last resort). • manage the payments system (settles interbank payments). • oversee commercial banks and the financial system (handles the sensitive information about institutions without conflicts of interest). 15-9 • By ensuring that sound banks and financial intermediaries can continue to operate, the central bank makes the whole financial system more stable. • Central banks are the biggest and most powerful players in a country’s financial and economic system and are supposed to use this power to stabilize the economy, making us all better off. 15-10 • However, central banks that are under extreme political pressure, or that are simply incompetent, can wreak havoc on the economic and financial systems. • A central bank does not control : • securities markets. • the government’s budget. 15-11 • The common arrangement today is for the central bank to serve the government in the same way that a commercial bank serves a business or an individual. 15-12 The Functions of a Modern Central Bank The Government’s Bank A: Manages the finances of the Govt. B: Controls the availability of money and credit through interest rates The Bankers’ Bank A: Guarantees that sound banks can do business by lending to them even during crisis B: Operates a payment system for interbank payments C: Oversees financial institutions to ensure confidence in their soundness 15-13 Stability: The Primary Objective of All Central Banks • When economic and financial systems are left on their own they are prone to episodes of extreme volatility; central bankers work to reduce that volatility • Central bankers pursue five specific objectives: • low and stable inflation • high and stable real growth, together with high employment • stable financial markets • stable interest rates • a stable exchange rate 15-14 • Instability in any of those would pose an economy-wide economic risk that diversification could not mitigate. • Thus the job of the central bank is to improve general economic welfare by managing and reducing systematic risk. • It is probably impossible to achieve all five of these objectives simultaneously, and so tradeoffs must be made 15-15 Low, Stable Inflation • Many central banks take as their primary job the maintenance of price stability; they strive to eliminate inflation. • The rationale for keeping the economy inflation-free is that money’s usefulness as a unit of account and as a store of value is enhanced when its purchasing power is maintained. 15-16 • Inflation degrades the information content of prices and impedes the market’s function of allocating resources to their best uses. • The higher the inflation is, the less predictable it is, and the more systematic risk it creates. • Also, high inflation is bad for growth. 15-17 • While there is agreement that low inflation should be the primary objective of monetary policy, there is no agreement on how low inflation should be. • Zero inflation is too low, because it brings the risk of deflation (a drop in prices) which in turn results in increased defaults on loans and a threat to the health of banks. 15-18 • Furthermore, if inflation were zero, an employer wishing to cut labor costs would need to cut nominal wages, which is difficult to do. • A small amount of inflation may actually make labor markets work better, at least from the employer’s point of view.