Question

Question 3.

Central banks often perform a number of functions in today’s economy. Address the questions about central banks that follow. Explain briefly and write words and sentences.

a. (6 points) Discuss the three key functions typically performed by central banks. For each function, provide an example of how the Federal Reserve performs that function. Explain briefly but fully. Write words and sentences

.b. (6points) Set up a T-account for the consolidated assets and liabilities of the Federal Reserve System, and list the Fed’s main assets and liabilities (and net worth) within this T-account. In normal times, which of the Fed’s assets is typically the largest share of its total assets? Which of the Fed’s liabilities is typically the largest share of its total liabilities (and net worth)? Explain briefly but fully. Write words and sentences.

c. Under fractional reserve banking, both the quantity of money supplied via the banking system and the total amount of credit extended by banks are governed by multiplier processes

.i)(11points) Using the definitions and notation from class and your reading, work out an expression for the money multiplier relating the monetary base to the M1-style measure of the quantity of money. Assume that banks issue only transactions deposits as liabilities and hold loans, securities, and reserves as assets. Briefly show your work, and explain all key steps. Write words and sentences

.ii)(11points) Using the definitions and notation from class and your reading, workout an expression for the total creditmultiplier relating the monetary base to the total quantity of bank credit. Assume that banks issue only transactions deposits as liabilities and hold loans, securities, and reserves as assets. Briefly show your work, and explain all key steps. Write words and sentences.

Answer 1

Solution Question 3 (a)

The Central Bank is the apex institution of a country's monetary system. Exact duties vary by country, but generally central banks main goals are to maintain a stable currency, control inflation and maximize employment through the promotion of reasonable economic growth. Example of central banks includes Federal Reserve Bank (US), The European Central Bank (EU) and The Bank of Japan (Japan).The main functions of a central bank are:

• Currency Authority.
• Banker’s Agent and Advisor to the Government.
• Banker’s Bank Supervisor.

Currency Authority Function

It means the central bank has the sole authority to issue currency. It brings uniformity in note circulation.

Example: Buying or selling government securities (Usually bonds) the Fed or a central bank affects the money supply and interest rates. By adding to the cash reserves of the commercial banks, then the fed enables these banks to increase their lending capacity.

Bankers Agent and Advisor to the Government

The central bank act as a banker’s agent and financial advisor to the government. It keeps the account of all government banks and manages government treasuries. It gives loans to the government, transfers government funds, buys and sells securities and treasury bills on behalf of the government. Being an apex bank of the country, it advises the government from time to time on economic and monetary matters.

Example: Government keeps their cash balances in the current account with the central bank. Central bank accepts receipts and makes payments on behalf of the government. Also central bank carries out exchange, remittance and other banking operations on behalf of government.

Bankers Bank Supervisor

The sole aim of these reserves is to enable the central bank to provide financial assistance in times of financial emergency. It supervises, regulates and controls the activities of commercial banks. It provides the commercial banks with centralized clearing and remittance facility.

Example: There are many banks in a country. There should be some agency to regulate and supervise their proper functioning. This duty is discharged by the central bank. It is the custodian of their cash reserve. Central bank is lender of last-resort whenever banks are short of funds, they can take loans from central banks. Central bank is a source of great strength to the banking system.