Lecture about Central Banking

1. Banking, Centrally
EC6012 International Monetary Economics Lecture 6
Stephen Kinsella
Dept. Economics,
University of Limerick.
stephen.kinsella@ul.ie
March 9, 2009
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 1 / 16

2. Today
Course Design
1
History
2
Central Bank Design
3
Central Bank Functions
4
Open Market Operations
5
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3. Course Design
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 3 / 16

4. Nice Quote
Recurring financial crises have become a hallmark of the modern
financial system. It would seem that, every five years or so, a
100-year event destabilizes the system. Moreover, each crisis
appears more violent than the previous one.
–Philipp M. Hildebrand, Is Basel II Enough? The Benefits of a Leverage
Ratio
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5. Basic Ideas
Lovely books: Minsky (1986), Davies (1994), Zelitzer (1994)
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

6. Basic Ideas
Lovely books: Minsky (1986), Davies (1994), Zelitzer (1994)
History of the ‘Big Bank’ Concept
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

7. Basic Ideas
Lovely books: Minsky (1986), Davies (1994), Zelitzer (1994)
History of the ‘Big Bank’ Concept
The Bank of England as a Template CB
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

8. Basic Ideas
Lovely books: Minsky (1986), Davies (1994), Zelitzer (1994)
History of the ‘Big Bank’ Concept
The Bank of England as a Template CB
The Bundesbank → ECB
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9. Bank of England
Of all institutions concerned with economics none has for so long
enjoyed such prestige. It is, in all respects, to money as
St. Peters is to the Faith. And the reputation is deserved, for
most of the art as well as much of the mystery associated with
the management of money originated there.
–J. K. Galbraith (1975, pg. 30)
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10. Functions of Any CB
Clear cheques
1
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11. Functions of Any CB
Clear cheques
1
Issue new currency
2
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

12. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

13. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

14. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Evaluate proposed mergers and applications for banks and other
5
financial intermediaries to expand their activities
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

15. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Evaluate proposed mergers and applications for banks and other
5
financial intermediaries to expand their activities
Act as liaisons between the business community and the monetary
6
policy community.
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

16. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Evaluate proposed mergers and applications for banks and other
5
financial intermediaries to expand their activities
Act as liaisons between the business community and the monetary
6
policy community.
Examine bank holding companies and state-chartered member banks
7
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

17. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Evaluate proposed mergers and applications for banks and other
5
financial intermediaries to expand their activities
Act as liaisons between the business community and the monetary
6
policy community.
Examine bank holding companies and state-chartered member banks
7
Collect data on local business conditions
8
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

18. Functions of Any CB
Clear cheques
1
Issue new currency
2
withdraw damaged currency from circulation
3
Administer and make discount loans to banks in their regions
4
Evaluate proposed mergers and applications for banks and other
5
financial intermediaries to expand their activities
Act as liaisons between the business community and the monetary
6
policy community.
Examine bank holding companies and state-chartered member banks
7
Collect data on local business conditions
8
Use their staffs of professional economists to research topics related
9
to the conduct of monetary policy.
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

19. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

20. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

21. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
To define and implement the monetary policy of the Community.
3
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

22. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
To define and implement the monetary policy of the Community.
3
To conduct foreign exchange operations.
4
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

23. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
To define and implement the monetary policy of the Community.
3
To conduct foreign exchange operations.
4
To hold and manage the official foreign reserves of the member states.
5
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

24. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
To define and implement the monetary policy of the Community.
3
To conduct foreign exchange operations.
4
To hold and manage the official foreign reserves of the member states.
5
To promote the smooth operation of payments systems
6
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

25. Task of ECB
The main tasks of the Eurosystem set out in Article 105 of the EC Treaty
are:
To maintain price stability.
1
To support the general economic policies in the Community.
2
To define and implement the monetary policy of the Community.
3
To conduct foreign exchange operations.
4
To hold and manage the official foreign reserves of the member states.
5
To promote the smooth operation of payments systems
6
To contribute to ‘the smooth conduct of policies pursued by the
7
competent authorities relating to the prudential supervision of credit
institutions, and the stability of the financial systems.
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

26. Money Supply Coordination
Figure: Simple domestic demand and supply of money with a fixed money supply.16
Stephen Kinsella (University of Limerick)
Banking, Centrally March 9, 2009 9/

27. Structure of CB’s Operations
Figure: Structure of Central Bank’s Operations.
Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 10 / 16

28. CB Balance Sheet
Assets(Uses of Funds) Liabilities (Sources of Funds)
Govt. Securities Currency in Circulation
Discount Loans Reserves
Table: Central Bank’s Balance Sheets
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29. Control
The central controls the level of money in the economy by manipulating
the monetary base, MB which is the level of currency in circulation, C ,
plus the total reserves in the banking system, R. The Federal reserve, for
example, directly manipulates the relationship
MB = C + R (1)
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30. OMOs
Figure: Causal structure of open market operations.
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31. Expansionary OMO
Figure: An expansionary open market operation.
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32. Next Time
Theories of Interest Rate Determination.
See Readings on the Web.
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33. References
Glyn Davies. A History of Money: From Ancient Times to the Present
Day. University of Wales Press, Cardiff, 1994.
J. K. Galbraith. Money: Whence it Came, Where it Went. Houghton
Mifflin Co., Boston, 1975.
Hyman P. Minsky. Stabilising an Unstable Economy. McGraw-Hill, New
York, 1986.
Viviana A. Zelitzer. The Social Meaning of Money. Basic Books, New
York, 1994.
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