Part 1
1.1 What are central bank and its main function?
A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state's legal tender.(Heakal, 2003)
The primary function of a central bank is to control the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking …show more content…
But while adjusting reserve requirements and interest rates are effective ways to change the money supply, their results aren't as quickly seen as is often necessary. That's where open market operations come in.(Gonzalo Camina Ceballos, 2015)
Open Market Operations
Open market operations are a way of affecting the money supply by buying or selling securities -- usually government securities. Essentially, if the Fed wants to increase the supply of money, it turns to the market and purchases Treasury securities (such as T-bills, T-notes and T-bonds). When it buys these securities, it gives the sellers money, and that increases the supply of money in the economy.
When the Fed wants to decrease the money supply, it does so by selling Treasury securities and collecting money in exchange. The Fed makes these trades by using its reserve cash. And because the Fed doesn't issue the securities that it trades to change the money supply, making good on the promises of those Treasury securities is the responsibility of the U.S. Treasury, not the …show more content…
Examples
Take the performance of the NZD/JPY currency pair between 2002 and 2005, for example. During that time, the central bank of New Zealand increased interest rates from 4.75% to 7.25%. Japan, on the other hand, kept its interest rates at 0%, which meant that the interest rate spread between the New Zealand dollar and the Japanese yen widened a full 250 basis points. This contributed to the NZD/JPY's 58% rally during the same period.
On the flip side, we see that throughout 2005, the British pound fell more than 8% against the U.S. dollar. Even though the United Kingdom had higher interest rates than the United States throughout those 12 months, the pound suffered as the interest rate spread narrowed from 250 basis points in the pound's favor to a premium of a mere 25 basis points. This confirms that it is the future direction of interest rates that matters most, not which country has a higher interest
1.1 What are central bank and its main function?
A central bank, reserve bank, or monetary authority is an institution that manages a state's currency, money supply, and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state's legal tender.(Heakal, 2003)
The primary function of a central bank is to control the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking …show more content…
But while adjusting reserve requirements and interest rates are effective ways to change the money supply, their results aren't as quickly seen as is often necessary. That's where open market operations come in.(Gonzalo Camina Ceballos, 2015)
Open Market Operations
Open market operations are a way of affecting the money supply by buying or selling securities -- usually government securities. Essentially, if the Fed wants to increase the supply of money, it turns to the market and purchases Treasury securities (such as T-bills, T-notes and T-bonds). When it buys these securities, it gives the sellers money, and that increases the supply of money in the economy.
When the Fed wants to decrease the money supply, it does so by selling Treasury securities and collecting money in exchange. The Fed makes these trades by using its reserve cash. And because the Fed doesn't issue the securities that it trades to change the money supply, making good on the promises of those Treasury securities is the responsibility of the U.S. Treasury, not the …show more content…
Examples
Take the performance of the NZD/JPY currency pair between 2002 and 2005, for example. During that time, the central bank of New Zealand increased interest rates from 4.75% to 7.25%. Japan, on the other hand, kept its interest rates at 0%, which meant that the interest rate spread between the New Zealand dollar and the Japanese yen widened a full 250 basis points. This contributed to the NZD/JPY's 58% rally during the same period.
On the flip side, we see that throughout 2005, the British pound fell more than 8% against the U.S. dollar. Even though the United Kingdom had higher interest rates than the United States throughout those 12 months, the pound suffered as the interest rate spread narrowed from 250 basis points in the pound's favor to a premium of a mere 25 basis points. This confirms that it is the future direction of interest rates that matters most, not which country has a higher interest