The second instrument of monetary control available to the central bank is the discount rate.
The discount rate is the interest rate that the Bank charges when the commercial banks want to borrow money.
Suppose banks think the minimum safe ratio of cash to deposits is 10%. Say their cash reserves are 12% of deposits. How far dare they let their cash reserves fall towards the minimum level of 10%?
Banks have to balance the interest rate they will get on extra lending with the dangers and costs involved if there is a sudden flood of withdrawals, which push their cash reserves below the critical 10% figure. This is where the discount rate comes in. Suppose market interest rates are 8% and the central bank makes it known it is prepared to lend to commercial banks at 8%. Commercial banks may as well lend up to the hilt and drive their cash reserves down to the minimum 10% of deposits. The banks are lending at 8% and, if the worst comes to the worst and they are short of cash, they can always borrow from the Bank at 8%. Banks cannot lose by lending as much as possible.
Suppose however that the Bank announces that, although market interest rates arc 8%, it will lend to commercial banks only at the penalty rate of 10%. Now a bank with cash reserves of 12% may conclude that it is not worth making the extra loans at 8% interest that would drive its cash reserves down to the minimum of 10% of deposits. There is too high a risk that sudden withdrawals will then force the bank to borrow from the Bank at 10% interest. It will have lost money by making these extra loans. It makes more sense to hold some excess cash reserves against the possibility of a sudden withdrawal.
Thus, by setting the discount rate at a penalty level in excess of the general level of interest rates, the Bank can induce commercial banks voluntarily to hold additional cash reserves. Since banks have to hold more cash as reserves, the money multiplier is reduced, less money can be created and the money supply is lower.
VOCABULARY NOTE
instruments of macroeconoinics
to control the money supply
the exchange rate ()
the amount of investment
to adjust the amount of money in circulation
implementation of a nation's monetary policy , -
to implement , ,
the Bank of England ( ). The Bank of England is the UK's central bank. Established in 1694, it plays a key part in implementing the government's monetary policy. It ensures that interest rates are at the level desired by the government of the day and oversees the printing of notes and coin. It has wider responsibilities in managing the nation's debt and holding its reserves of foreign currency and gold. Thus, it holds responsibility for the country's monetary policy and its financial relations with other countries.
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on behalf of
reserve requirements
a discount rate
the money multiplier
required reserves
easily convertible into cash (., , )
a required reserve ratio
cash reserves
excess reserves
to draw (syn. to write out, to make out, to issue) a cheque
created money
inversely proportional (ant. directly proportional)
to maintain
to impose a reserve requirement ()
fraction ,
in excess of smth -
prudent ,
in force
to charge ,
to lend up to the hilt .
up to the hilt ,
drive their cash reserves down to... () ...
if the worst comes to the worst
they are short of cash
the penalty rate ()
it is not worth making the extra loans
to induce smb to do smth (syn. to cause smb to do smth) - -
voluntarily ,
Assignments
I. Suggest the Russian equivalents
to restore their required reserve ratio; maintain cash reserves equal to 5% of sight deposits; create $20 million of sight deposits; a higher fraction of their total assets; a lower fraction as loans; the interest rate that the Bank charges;
extra lending; impose a reserve requirement; the dangers and costs involved;
prudent banks; lend up to the hilt; the minimum safe ratio of cash to deposits;
flood of withdrawals; the Bank can induce banks voluntarily to hold additional cash reserves; the required reserve ratio given
II. Replace the parts in italics by synonyms
implements monetary policy; plays a major role; operates monetary policy;
extra lending; if the worst comes to the worst; they are short o/"cash; to affect the money supply; in excess of the reserve ratio
III. Fill in the gaps with the words and expressions from the text
1. Monetary policy is a method of controlling the economy that centres on __ the amount of money __ in the economy and so __ and __.
2. In some countries the Central Bank operates monetary policy __ government policy, but the UK's Central Bank implements monetary policy __ the government.
3. Monetary policy has three main aspects: controlling __, controlling __, managing __.
4. The aim of the authorities when controlling the money supply is __, and hence __, by businesses and individuals during __.
5. It is hoped to limit the level of __ in the economy and thus to remove or reduce __.
6. During a recession monetary policy is aimed at __ to __ spendings.
7. The three most important instruments __ the money supply are __, __ and __.
8. Open market operations refer to the Bank trading government bonds __, that is when they are bought from and sold to __.
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9. When the Bank sells __ in the open market, the Bank __ the money from population and __ the money supply.
10. When the Bank buys government bonds in the open market, it __ the amount of money __ and hence __.
11. Banks have to hold a proportion of their assets __ in case customers demand __.
12. The required reserve hasto be __, that is easily __ into cash.
13. __ is a minimum ratio of __ to __ that the central bank requires commercial banks to hold.
14. If cash of commercial banks __ the required amount, they must immediately __ cash, usually from __, to restore their __.
15. Commercial banks can make loans, i.e. they can __ and increase __.
16. The money multiplier (m) shows __, which can be created by one dollar of __, the required reserve ratio __.
17. The money multiplier is __ to the required reserve ratio, it means that the larger __ is the smaller __ is; the less money __ and the less __ is.
18. Since sight deposits will be 20 times cash reserves, the banking system will create $20 million of__ against its $1 million __.
19. A reserve requirement acts like __ by forcing them to hold __ of their total assets as __ and __ as loans earning __.
20. When the central bank imposes a reserve requirement __ the reserve ratio, the effect is to reduce __, reduce __, and reduce __.
21. When a particular reserve-requirement is already __, any increase in __ will reduce __.
22. The discount rate is __ that the Bank __ when the commercial banks want __.
23. Banks have to balance __ they will get on extra lending with __ if there is __, which push their cash reserves __.
24. Commercial banks may as well lend up __ and __ their cash reserves __ to the minimum.
25. If the worst __ and commercial banks __, they can always __ the Bank.
26. The Bank announces that it will lend to commercial banks only at __.
27. If the Bank imposes a penalty rate, a commercial bank may conclude that __ making the extra loans.
28. There is too high a risk that __ will then force the bank to __ the Bank at the penalty interest rate.
29. It makes more sense to hold __ against the possibility of __.
30. By setting the discount rate at __ in excess of __ of interest rates, the Bank can __ commercial banks __ to hold __.
31. Since banks have to hold more cash as reserves, __ is reduced, less money can __ and __ is lower.
IV. Find in the text English equivalents for the following
; - ; ; ; ; ; ; ( ); ; ;
; ; () ; ;
V. Explain in English
a money multiplier; required reserves; excess reserves; a required reserve ratio; a discount rate
VI. Answer the questions
1. What is the aim of monetary policy?
2. Why is it important to control the money supply?
3. Dwell on open market operations.
4. Explain the creation of money by commercial banks. What does a money multiplier show?
5. Why does the Bank impose a reserve requirement? What's the effect of the Bank imposing a reserve requirement?
6. Why does a reserve requirement act like a tax on banks?
7. What is a discount rate? How does it work?
VII. Translate into English using all the active possible
1. - , . - , . : -' , , , .
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2. - :
, .
3. . , .
4. , , . , , , .
5. , , , . .
6. .
7. , .
THE ECONOMIC ENVIRONMENT ( )....................... 1
MEASURING ECONOMIC ACTIVITY ( ) 5
THREE ECONOMIC ISSUES ( )............................. 9
INCOME ()....................................................................................................... 16
THE ROLE OF GOVERNMENT ( )................................. 19
THE PRODUCTION POSSIBILITY FRONTIER ( ) 24
ECONOMIC SYSTEMS ( ).................................. 27
MARKETS ().................................................................................................... 37
POSITIVE AND NORMATIVE ECONOMICS ( ) 42
MICROECONOMICS AND MACROECONOMICS ( ) 47
RI AND DEMAND ( )............................................................... 52
PRICE, INCOME AND DEMAND (, )............................. 57
ELASTIC AND INELASTIC DEMAND ( ) 59
A MODEL OF THE ECONOMY ( ).................................. 64
INJECTIONS ( )........................................... 69
WITHDRAWALS ( )............................... 74
INFLATION ()........................................................................................ 78
THE IMPACT OF INFLATION ON BUSINESS ( ) 81
CAN INFLATION BE BENEFICIAL ( )? 84
MONEY AND BANKING ( )............................. 87
THE ROLE OF BANKS ( )................................................................. 92
MODERN BANKING ( )................ 97
MONEY AND THE RETURN IT EARNS ( , ) 103
INTEREST RATES AND BOND PRICES ( ) 106
THE MONEY SUPPLY AND THE DEMAND FOR MONEY ( ) 108
THE MONEY MARKET ( ).............................................................. 112
MARKETS AND INTEREST RATES ( )........... 115
PRIMARY AND SECONDARY MARKETS ( ) 118
MONETARY POLICY (- )........................ 120
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