Central Banking

Theory and Practice in Sustaining Monetary and Financial Stability

Thammarak Moenjak

• Publisher: Wiley
• Year: 2014
• ISBN:
  9781118832578
• Edition: 1
• Topic: Economics
• Subtopic: Banks & Banking
• Index: Economics

Understand the theories and interpret the actions of modern central banks

Central Banking takes a comprehensive look at the topic of central banking, and provides readers with an understanding and insights into the roles and functions of modern central banks in advanced as well as emerging economies, theories behind their thinking, and actual operations practices. The book takes a systematic approach to the topic, while providing an accessible format and style that is appropriate for general audiences and students with only a minimal macroeconomic background. Theoretical reviews and examples of how the theories are applied in practice are presented in an easy-to-understand manner and serve as a guide for readers to further investigate specific ancillary central banking topics and as a means to make informed judgments about central bank actions. Important topics covered in the book include:

• Evolution of central banking functions and the international monetary system
• Theoretical backgrounds that are the foundation to the modern practice of monetary policy
• Monetary policy regimes, including exchange rate targeting, money supply growth targeting, the risk management approach, inflation targeting, and unconventional monetary policy.
• Actual practice in market operations and transmission mechanisms of monetary policy
• The exchange rate and central banking
• Theoretical backgrounds related to various dimensions of financial stability
• Current developments with regards to sustaining financial stability
• The future of central banking in the wake of the 2007-2010 global financial crisis
• Case studies on relevant practical issues and key concepts in central banking

Designed as essential reading for students, market analysts, investors, and central banks' new recruits, Central Banking better positions readers to interpret the actions of central banks and to understand the complexities of their position in the global financial arena.

Part One
An Introduction to Central Banking

Part I provides background on central banking.

Chapter 1 briefly reviews the evolution of central banking since its start about 400 years ago and how different functions of central banks came about.

Chapter 2 provides background on the international monetary system. Central banking has had an international dimension since the start, and to understand central banking it is very important to know the international monetary system that central banks operate in.

Chapter 3 reviews the functions of modern central banks. Although specifics do differ among central banks, there are commonalities as well as differences among modern central bank functions.

Chapter 4 reviews modern central bank mandates, that is, their key objectives. Again, there are commonalities and differences across central banks. Three key mandates are discussed: monetary stability, financial stability, and (particularly in the case of the United States) full employment.

Chapter 1
A Brief Look at Central Banking History

Learning Objectives

1. Describe historical roles and functions of central banks.
2. Explain how various central banking roles and functions came about.
3. Define money and its relation to central banking.
4. Describe key commonalities and differences of modern central banks.

Historically, central banking is a relatively new phenomenon, tracing its origin to about 400 years ago. In that relatively short period of time, however, central banks have evolved to become among the most important public institutions, which profoundly affect everyone’s daily life. This chapter briefly reviews the evolution of central banking in various stages, so the reader will understand the background of how central banks rose to become what they are today.

The chapter starts with the context in which the central bank was first created. Earlier roles of central banks—such as coin sorting, banknote issuance, banker to the government, and banker to banks—will first be discussed. Later, the chapter looks at newer roles of central banks, such as the lender of last resort, bank supervisor, and the conductor of monetary policy. Lastly, the chapter looks at the current stage of central banking, especially in the wake of the 2007–2010 global financial crisis that led to extensive reexamination of the role of central banks around the world.

1.1 PRIOR TO CENTRAL BANKING

Prior to the creation of central banks, societies often used precious metals such as gold or silver as the means of transaction for goods and services. In economic terms, precious metals were deemed suitable for being money, as they possessed three inherent characteristics. First, these metals were widely accepted as a medium of exchange. People were willing to trade their goods and services for precious metals, since they believed that they could use the metals to trade for other goods and services that they wanted to consume. Second, these metals were a good store of value. People who received these metals could keep them for future trading for what they might want to consume. Unlike grains or livestock, precious metals were not perishable, nor would they easily lose their luster. Third, they could be used as units of account, for they could be divided into uniform pieces according to the assigned value.

1.2 COIN SORTING AND STORING

When a society developed to a certain degree, the use of precious metals as money became more formalized and standardized. The metals were made into coins, which made them easier to transport. They were also stamped with seals or signs certifying their weight and value, which made it easier to recognize and classify them.

In Europe, by the seventeenth century, the use of coins in commerce became more cumbersome and required more effort for merchants. Different sovereigns introduced different makes of coins that were of different values and different metal content but circulated quite freely across borders. Different vintages of coins of the same nominal value from the same sovereign could also have different metal content, as sovereigns sometimes sought extra revenue by introducing coins of the same value with lighter and lighter metal content—that is, coin debasement.¹

Furthermore, there were also risks that the coins might be worn out because of usage, such that the precious metal content became diminished, or they might be intentionally clipped, as people chipped out metal content from the coins.²

To ease the problems related to coin usage, in 1609 merchants and the city of Amsterdam, a premier global trading hub of that time, decided to set up the Bank of Amsterdam to do the tasks of sorting, classifying, and storing the coins. The success of the Bank of Amsterdam prompted other European cities and sovereigns to set up banks along the lines of the Bank of Amsterdam.³

1.3 BANKNOTE ISSUANCE

In 1656, the Bank of Stockholm was established in Sweden, in the fashion of the Bank of Amsterdam. At first, the bank simply took in copper coins and lent out against tangible assets such as real estate.⁴ Five years later, however, as the Swedish parliament decided to reduce the amount of copper in newly minted coins, older coins of the same nominal face value became more valuable owing to their greater copper content. The public rushed to get their hands on the older coins, and the bank run threatened the Bank of Stockholm’s survival.

The solution by the Bank of Stockholm to prevent the threat that it might run out of coins was to issue notes of credit (called kreditivsedlar) to those depositors who wanted to withdraw their copper coins. With their features of having fixed face values in round denominations, no paid interest, and being freely transferable from one holder to another, these kreditivsedlar were considered the first banknotes in the modern sense.⁵ This solution was a success for about two years until the Bank of Stockholm could not redeem the notes at their face values and the government had to intervene.

In 1668, the Swedish parliament approved a new bank to replace the Bank of Stockholm. Ultimately, that new bank became the present-day Swedish central bank, the Sveriges Riksbank, currently the world’s oldest central bank. (The Bank of Amsterdam collapsed in 1819, suffering losses from their investments in the Dutch East India Company, which financed wars with England.⁶)

Despite the demise of the Bank of Stockholm, the use of banknotes as a medium of exchange survived and gradually became embedded in our modern economies. As merchants who had coins deposited at the bank traded goods and services among themselves, it was clearly easier for them to transfer their coin ownerships at the bank without withdrawing those coins to settle their trades. Therefore, it was also easier for the bank to just issue notes for those who owned coins held at the bank so that they could use the notes to trade with those without accounts at the bank. In the few centuries after the pioneer banknote issuance by the Bank of Stockholm, banknote issuance became popular in many countries, but was not confined only to banks established by governments or sovereigns. In many countries, privately owned banks were also granted the right to issue their own banknotes.

1.4 BANKER TO THE GOVERNMENT

The Swedish Riksbank was chartered to not only act as a clearinghouse for merchants but also to lend funds to the government. Later on, many other central banks were also created to help finance government spending, particularly to finance wars. These included (1) the Bank of England, which was founded in 1694 as a joint stock company to finance the war with France and was later also given the privilege of handling the government’s...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Preface
• Acknowledgments
• About the Author
• Part One: An Introduction to Central Banking
• Part Two: Monetary Stability
• Part Three: Financial Stability
• Part Four: Sustaining Monetary and Financial Stability for the Next Era
• Index
• End User License Agreement