CH4 Central Bank

Slide 5.
Part 2
Central banking and
bank regulation
Chapter 4
Theory of central
banking
Casu, Girardone and Molyneux, Introduction to Banking PowerPoints on the Web, 2nd edition © Pearson Education Limited 2015
Slide 5.2
Learning objectives
• To understand the crucial role of central banks in the

financial sector
• To describe the main functions of the central bank
• To understand the monetary policy functions of
central banks
• To understand the arguments put forward by the free
banking theorists
• To discuss the arguments for and against an
independent central bank
• To understand the relevance of central banks
during financial crises
Slide 5.3
Functions of the Federal Reserve

Banks (1 of 2)
1 Issue new currency
2 Withdraw damaged currency from circulation

3Administer and make discount loans to banks
in their districts
4Evaluate proposed mergers and applications
for banks to expand their activities
Slide 5.4
Functions of the Federal Reserve

Banks (2 of 2)
5Act as liaisons between the business
community and the Federal Reserve System
6 Collect data on local business conditions
7Use staffs of professional economists to
research topics related to the conduct of
monetary policy
Slide 5.5
Figure 5.1 Weight of central bank objectives in central bank laws

Source: Bank for International Settlements (2009b) p. 21.
Slide 5.6
On The Special Role of the Federal

Reserve Bank of New York (1 of 2)
• The Federal Reserve Bank of New York plays a
special role in the Federal Reserve System for
several reasons.
– First, its district contains many of the largest
commercial banks in the United States, the safety
and soundness of which are paramount to the
health of the U.S. financial system.
– The second reason for the New York Fed’s special
role is its active involvement in the bond and
foreign exchange markets.
Slide 5.7
How Independent Is the Fed?

• Instrument and goal independence.
• Independent revenue
• Fed’s structure is written by Congress, and is
subject to change at any time.
Slide 5.8
Should the Fed Be Independent?

• The Case for Independence
– The strongest argument for an independent central
bank rests on the view that subjecting it to more
political pressures would impart an inflationary bias to
monetary policy.
• The Case Against Independence
– Proponents of a Fed under the control of the
president or Congress argue that it is undemocratic to
have monetary policy (which affects almost everyone
in the economy) controlled by an elite group that is
responsible to no one.
Slide 5.9
Figure 5.7 The key issues in monetary policy transmission
Slide 5.10
Figure 6.3 The new UK financial regulation architecture
Slide 5.11
Figure 6.10 The stability-oriented monetary policy strategy of the ECB

Source: Adapted from www.ecb.int
Slide 5.12
The Federal Reserve’s Balance Sheet and the

Monetary Base
The model of how the money supply is determined includes three actors:
1.The Federal Reserve: responsible for controlling the money supply and
regulating the banking system.
2. The banking system: creates the checking accounts that are a major
component of M1.
3.The nonbank public (all households and firms): decides the form in which they
wish to hold money (e.g., currency vs. checking deposits).
The Federal Reserve’s Balance Sheet and the Monetary Base

Slide 5.13
The process starts with the monetary base.
Monetary base (or high-powered money) is the sum of bank reserves and
currency in circulation.
Monetary base = Currency in circulation + Reserves.

Slide 5.14
Reserves = Required reserves + Excess reserves.
Required reserves are reserves that the Fed requires banks to hold.
Excess reserves are reserves that banks hold above those the Fed requires to hold.
Reserves = Required reserves + Excess reserves.
Required reserve ratio is the percentage of checkable deposits that the Fed
specifies that banks must hold as reserves.

Slide 5.15
Figure 5.2 Monetary policy instruments, targets and goals
Slide 5.16
How the Fed Changes the Monetary Base
The Fed changes the monetary base by changing the levels of its assets— through
buying and selling Treasury securities or making discount loans to banks.
Open market operations are the Fed’s purchases and sales of securities,
usually U.S. Treasury securities, in financial markets.
• Open market purchase is the Fed’s purchase of securities.
• Open market sale is the Fed’s sale of securities.
Open market operations are carried out electronically with primary dealers
(banks) by the Fed’s trading desk.

Slide 5.17
Figure 5.3 Open market operations
Slide 5.18
Comparing Open Market Operations and Discount

Loans
Both open market operations and discount loans change the monetary base,
but the Fed has greater control over open market operations.
Discount rate is the interest rate the Fed charges on discount loans.
The discount rate differs from most interest rates because it is set by the Fed,
whereas most interest rates are determined by demand and supply in financial
markets.
.

Slide 5.19
Figure 5.4 Discount window
Slide 5.20
Figure 5.6 Reserve requirements

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Slide 5.

• To understand the crucial role of central banks in the

Functions of the Federal Reserve

2 Withdraw damaged currency from circulation

Functions of the Federal Reserve

Figure 5.1 Weight of central bank objectives in central bank laws

On The Special Role of the Federal

How Independent Is the Fed?

Should the Fed Be Independent?

Figure 5.7 The key issues in monetary policy transmission

Figure 6.3 The new UK financial regulation architecture

Figure 6.10 The stability-oriented monetary policy strategy of the ECB

The Federal Reserve’s Balance Sheet and the

The Federal Reserve’s Balance Sheet and the Monetary Base

The process starts with the monetary base.

Monetary base = Currency in circulation + Reserves.

The Federal Reserve’s Balance Sheet and the Monetary Base

Reserves = Required reserves + Excess reserves.

Reserves = Required reserves + Excess reserves.

The Federal Reserve’s Balance Sheet and the Monetary Base

Figure 5.2 Monetary policy instruments, targets and goals

How the Fed Changes the Monetary Base

The Federal Reserve’s Balance Sheet and the Monetary Base

Figure 5.3 Open market operations

Comparing Open Market Operations and Discount

The Federal Reserve’s Balance Sheet and the Monetary Base

Figure 5.4 Discount window

Figure 5.6 Reserve requirements

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