Modern Banking - Central Bank

how are banking crises in advanced economies?

last longer and are more severe

because more important financial systems and more people use banks

Why is government intervention necessary in the financial sector?

is necessary because banks are fragile and can experience bank runs when too many people withdraw money at once. Crises can arise from panics, real economic problems, or lack of information, prompting government support to stabilize the financial system.

what is solvency?

the banks owns more than it owes

what is liquidity?

the bank has enough cash to give people their money when they ask

what is the self-fulfiling prophecy in bank runs?

people panic and withdraw their money

• bank not enough liquidity

• even if he is solvent

• problem of contagion

what also can cause bank runs?

• downturns in the business cycle

• recessions

• deflation

What are the effects of recessions on banking?

businesses slow down, leading to higher loan defaults and reduced bank lending. This creates a cycle where decreased lending further weakens the economy, exacerbating the recession.

How does deflation impact banks?

the value of assets falls while loan payments remain fixed, making borrowers appear riskier. This leads banks to tighten lending, reducing overall spending and investment, which can worsen economic conditions.

how do downturns in the business cycle affect banks?

When the economy slows down, people and businesses may struggle to repay their loans. At the same time, the value of things the bank owns (like stocks or bonds) can drop. Both of these problems can hurt the bank’s financial health.

what is the fundamental feature of financial systems?

• interconnectedness

If one bank has problems, those problems can spread to other

What is interconnectedness in the banking sector?

• direct contagion → if one bank can’t repay a loan it got from another bank.

• indirect contagion →If a bank sells its assets quickly at low prices (called fire sales), it can cause the value of those assets to drop for everyone else too.

What is the main goal of regulation in the financial system?

is to protect the economy by reducing significant risks and ensuring the financial system operates effectively for everyone.

What roles do central banks serve?

• government's bank, facilitating payments and holding government accounts

  → print money and control inflation with interest rates

• banks' bank, providing loans to other banks and acting as a lender of last resort.

  →lend money, handle payments and make sure banks play by the rules

what central banks are not?

• do not control securities markets

• do not control government budget

how to achieve low volatility in the economic and financial systems?

• keep inflation low and stable

• support steady economic growth and jobs

• keep financial market and institutions stable

• keep interest rates stable

how central bank should be?

• independence →Monetary decisions must be made free of political influence

• accountability and transparency

• policy framework

• decision making committee →collective decisions but clear chain of command

What is the difference between monetary policy and fiscal policy?

• Monetary policy involves managing the money supply and interest rates

• fiscal policy involves government spending and taxation decisions.

What happens when government debt is monetized?

it may rely on the central bank to buy its bonds, which can lead to inflation if too much money enters the economy.

why governments are tempted to have and inflation?

Inflation is sometimes used by governments as a hidden way to reduce their debt, but it can harm the overall economy in the long run.

What components make up a central bank's balance sheet?

• Assets = what the central bank owns (e.g., loans, securities, foreign reserves)

• Liabilities = what the central bank owes (e.g., currency in circulation, bank reserves)

• The monetary base is the sum of:

-              Currency (cash with the public)

-              Reserves (money held by commercial banks at the central bank)

→crises change balance sheet of central banks

How can a central bank change its balance sheet?

• Open market operation →buying or selling assets (e.g., bonds) → increases reserves and monetary base

• Discount loan → giving loans to banks → increases reserves and monetary base

• Cash withdrawal → Letting people withdraw cash → decreases the reserves, increases currency and monetary base unchanged