© the mcgraw-hill companies, inc., 2008 mcgraw-hill/irwin chapter 15 central banks in the world...
TRANSCRIPT
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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Chapter 15
Central Banks in the World Today
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Central Banks:The Big Questions
1. What is the role of the central bank?
2. What are the central bank’s objectives?
3. How are successful central bank’s organized?
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Central Banks:Roadmap
• The origins and roles of central banks
• Central bank objectives
• Designing a successful central bank
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Central Banks:Origins and Roles
• There are about 170 central banks in the world today. Nearly every country has one.
• When the Soviet Union collapsed in 1990, the 12 of the 15 republics had central banks within a year
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Central Banks:Origins and Roles
• Special type of financial intermediary
• Origin:– To provide for government finance– Originally private institutions
• Roles– Government’s bank– Banker’s bank
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Central Banks:The Government’s Bank
• Manage the finances of the government
• Central banks create money They print currency
• Control availability of money and credit
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• Counterfeiting has been used as a weapon in wartime
• Goal to destabilize enemy’s currency
• Without a stable currency it is difficult for an economy to run efficiently
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Central Banks:The Bankers’ Bank
• Operate interbank payments network
• Provide loans during periods of crisis
• Oversee financial intermediaries to insure safety and soundness
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Functions of a Modern Central Bank
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Central Bank Objectives:Stability
• Low and stable inflation
• High and stable growth
• Stable financial markets
• Interest-rate stability
• Exchange-rate stability
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Central Bank Objectives:Low & Stable Inflation
• Strive to eliminate inflationA dollar should always be worth a dollar– Prices are central to a market economy
Allocating resources to their best uses
– Inflation makes it more difficult to tell – High inflation is less predictable
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• High inflation is volatile inflation
• Volatile inflation means more risk
• Risk requires compensation
• High inflation means a higher risk premium, so higher loan rates
• Volatile inflation makes long-term planning difficult
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Central Bank Objectives:High & Stable Real Growth
• Support maximum sustainable growth
• Stable countries grow faster– Unstable growth creates risk– Unstable growth drives up interest rates– Higher interest rates me lower borrowing– Less borrowing means less investment– Less investment means less growth
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Central Bank Objectives:Financial System Stability
• When the financial system collapses, everything else goes with it.
• Can’t get car loans or mortgages
• Banks cease to operate properly
(Application of value-at-risk)
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Central Bank Objectives: Interest-Rate Stability
• Stable interest rates make economic decisions easier
• Stable short-term interest rates reduce risk premium on long-term interest rates
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Central Bank Objectives: Exchange-Rate Stability
• The more open an economy, the more important it is
• Makes cost of imports and revenue from exports more predictable
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Central Bank Objectives:Summary
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• Fed controls short-term interest rate
• News about future short-term interest rate affects long-term interest rates
• When long-term interest rates change, so do car loan and mortgage rates
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Designing a Successful Central Bank
• Independence
• Decision-making Framework
• Accountability, Transparency and Communication
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Central Bank Design:Independence
• Central banks need to be independent of political pressure
• Politicians have an incentive to create short-term prosperity at the expense of inflation tomorrow.
• Longer time horizon needed to avoid “inflation bias”
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Independent Central Banks Deliver Low Inflation
What drove politicians to give up control over monetary policy?
Realization that independent central bankers would deliver low inflation.
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Central Bank Design:Decision-Making Framework
• Should policy be made by an individual or by a committee?Committees provide safeguards against
putting the wrong person in charge
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Central Bank Design: Accountability, Transparency and Communication
• Central Bank Independence is inconsistent with representative democracy
• Solution:– Give central bankers clear objectives– Force them to tell us what they are doing
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Central Bank Design:Policy Tradeoffs
• Can’t always have everything at once– Sometimes the economy is hit by a shock
that drives inflation and growth in opposite directions
– Creates a tradeoff– Central bankers must be honest about the
fact that goals are sometimes in conflict
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Central Bank Design:Summary
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Central Banksand Fiscal Policy
• In emerging market countries like Brazil and Argentina, fiscal policy problems can make it impossible for central bankers to keep inflation low
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Central Banksand Fiscal Policy
• Fiscal authorities have 3 sources of funds– Taxes– Borrowing– Money printing
• The first 2 work only up to some limit• If the budget is unsustainable, force
money printing
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Central Banks and Fiscal Policy:Argentina in 2002
• Financial collapse tied to the regional government’s issuance of their own currency
• Made it so that the Central Bank of Argentina was helpless
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Web Links
Federal Reserve SystemBank of EnglandEuropean Central BankBank of Japan (English)Reserve Bank of AustraliaReserve Bank of New ZealandBank of Canada (English)Banco de Mexico (English)
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© The McGraw-Hill Companies, Inc., 2008McGraw-Hill/Irwin
Chapter 15
End of Chapter