Central Banks

Banker's Bank Function

-it does not control securities markets, though it may monitor and participate in bond and stock markets -it does not control the government's budget (determined through fiscal policy) 1. Guarantees that sound intermediaries can do business by lending to them, even during crisises 2. Operates a payments system for interbank payments 3. Oversees financial institutions to ensure confidence in their soundness

Central Bank's three key roles

1. To provide loans during times of financial stress 2. To manage the payments system 3. To oversee commercial banks and the financial system -they have the ability to create money so that they can make loans even when no one else can

high and stable real growth

-adjust interest rates to stabilize growth and employment -long-run normal level of production called potential output -growth in inputs leads to growth in potential output (sustainable growth)

Monetary policy

-adjusting short-term interest rates -it is used to stabilize economic growth and information

Hyperinflation

-high inflation is bad for growth -prices contain virtually no info -people use all their energy just coping with the crisis so growth plummets -However, zero inflation is just as bad because their is a risk of deflation making it more difficult to repay debts

The primary objective of all central banks

-is providing stability

Fiscal policy

-Government spending and tax policies to influence macroeconomic conditions, including aggregate demand, employment, inflation, and economic growth

Low, stable inflation

-maintenance of price stability -strive to eliminate inflation -when inflation rises too high, or falls too low for an extended period, the central bank is at fault -maintaining price stability enhances money's usefulness both as a unit of account and as a store of value -prices provide info and ensure resources are allocated to their most productive uses -inflation degrades the info content of prices -the higher the inflation, the less predictable it is, and the more systematic risk it creates

Value at risk

-measures the risk of the maximum potential loss of a specific intermediary

Glass-Steagall Act

-separated commercial banking from investment banking -commercial banks were regulated -commercial banks started trading more which increased risk but soon funding stopped

Financial system stability

-the Fed was founded to stop financial panics that plagued the U.S. during the late 19th and early 20th centuries -financial system stability: an integral part of every modern central banker's job -if people lose faith in financial institutions and markets, they will rush to low-risk alternatives which leads to systematic risk

Central Bank controls

-the availability of money and credit in a country's economy

Interest-Rate and exchange-rate stability

-when exchange rates are stable, the dollar price of goods is predictable and planning ahead is easier for everyone -exports and imports are central to the structure of the economy

Government's Bank Functions

1. Execute financial transactions for the government 2. Through interest rates, controls the availability of money and credit

Ways to reduce volatility of the economic and financial systems

1. Having low and stable inflation 2. High and stable real growth, together with high employment 3. Stable financial market and institutions 4. Stable interest rates 5. A stable exchange rate (it's difficult to achieve all of them so there are tradeoffs) -instability of these objectives poses a systematic risk (economy-wide risk)