Banking, Centrally

Banking, CentrallyEC6012 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

Today

1 Course Design

2 History

3 Central Bank Design

4 Central Bank Functions

5 Open Market Operations

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Course Design

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 3 / 16

Nice Quote

Recurring financial crises have become a hallmark of the modernfinancial system. It would seem that, every five years or so, a100-year event destabilizes the system. Moreover, each crisisappears more violent than the previous one.

–Philipp M. Hildebrand, Is Basel II Enough? The Benefits of a LeverageRatio

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 4 / 16

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

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

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

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

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

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

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

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 5 / 16

Bank of England

Of all institutions concerned with economics none has for so longenjoyed such prestige. It is, in all respects, to money asSt. Peters is to the Faith. And the reputation is deserved, formost of the art as well as much of the mystery associated withthe management of money originated there.

–J. K. Galbraith (1975, pg. 30)

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 6 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Functions of Any CB

1 Clear cheques

2 Issue new currency

3 withdraw damaged currency from circulation

4 Administer and make discount loans to banks in their regions

5 Evaluate proposed mergers and applications for banks and otherfinancial intermediaries to expand their activities

6 Act as liaisons between the business community and the monetarypolicy community.

7 Examine bank holding companies and state-chartered member banks

8 Collect data on local business conditions

9 Use their staffs of professional economists to research topics relatedto the conduct of monetary policy.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 7 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Task of ECB

The main tasks of the Eurosystem set out in Article 105 of the EC Treatyare:

1 To maintain price stability.

2 To support the general economic policies in the Community.

3 To define and implement the monetary policy of the Community.

4 To conduct foreign exchange operations.

5 To hold and manage the official foreign reserves of the member states.

6 To promote the smooth operation of payments systems

7 To contribute to ‘the smooth conduct of policies pursued by thecompetent authorities relating to the prudential supervision of creditinstitutions, and the stability of the financial systems.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 8 / 16

Money Supply Coordination

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

Structure of CB’s Operations

Figure: Structure of Central Bank’s Operations.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 10 / 16

CB Balance Sheet

Assets(Uses of Funds) Liabilities (Sources of Funds)

Govt. Securities Currency in CirculationDiscount Loans Reserves

Table: Central Bank’s Balance Sheets

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 11 / 16

Control

The central controls the level of money in the economy by manipulatingthe monetary base, MB which is the level of currency in circulation, C ,plus the total reserves in the banking system, R. The Federal reserve, forexample, directly manipulates the relationship

MB = C + R (1)

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OMOs

Figure: Causal structure of open market operations.

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Expansionary OMO

Figure: An expansionary open market operation.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 14 / 16

Next Time

Theories of Interest Rate Determination.See Readings on the Web.

Stephen Kinsella (University of Limerick) Banking, Centrally March 9, 2009 15 / 16

References

Glyn Davies. A History of Money: From Ancient Times to the PresentDay. University of Wales Press, Cardiff, 1994.

J. K. Galbraith. Money: Whence it Came, Where it Went. HoughtonMifflin Co., Boston, 1975.

Hyman P. Minsky. Stabilising an Unstable Economy. McGraw-Hill, NewYork, 1986.

Viviana A. Zelitzer. The Social Meaning of Money. Basic Books, NewYork, 1994.

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