Central Banks What Criteria Are essay

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Under the arrangement, moreover, a country with efficient production and a favored competitive position (including as enhanced by new capital goods) is rewarded with rising income and reduced unemployment. No grand scheme of state or international planning and direct control is required. Exchange rates are for the most part fixed under the classical gold-flows mechanisms (say, $/£ const. within fixed limits), as stated, and adjustments to trade imbalances take place through price-level changes (e.g., PU.S. versus P. UK ) or product prices (and the special part of product prices called wages) (Bullard & Christopher 2004 101). Faced with unemployment, a country's position can be improved by enhancing productivity and having prices on its real goods and services and wages adjust downward relative to those of other countries.

Another way to achieve adjustments in trade positions (or more generally balance of international payments positions) is to have exchange rate changes rather than price changes. Whatever the case-exclusive of full floating that the world does not come to -- some elements of economic efficiency and wage and price discipline (via relative prices, as under the gold-flows mechanism) enter from an international point-of-view. This mechanism of monetary flows and price-level discipline, as it were, impacts on the domestic monetary mechanism (the G. term in the bank reserve equation). Complexities aside, in principle the idea is that of a stock of reserves being identical to factors such as international monetary reserves, and credit extended by the central bank (with discount windows and open market operations as the principal sources).

These reserves, in turn, support liabilities of banking institutions (mainly, since the National Banking Act in the United States, deposit liabilities). These liabilities are in the form of bookkeeping entries. They are a part of the money supply, and paper and other currency can be freely exchanged for the deposit liabilities. Here is the idea of a money supply (the currency and deposit liabilities) that can vary in its measures, depending on the assets included from the point-of-view of the economic "agent" (Briault, et al. 1997 301). Since reserves can be controlled, allowing for various factors, they have a link with the money supply, which in turn can be controlled, after allowances for shifts in the liquidity preference necessities for reserves, because of the banks themselves, and other factors such as changes in the ratio of the currency held by the public to deposit liabilities.

The bookkeeping entries on the liabilities side are a part of the money supply, as stated, and they may come about as bank credit expands in response to increases in bank reserves (mostly via open market operations, or historically gold inflows). The expansion of the money supply comes about via banks extending credit (loans), or purchasing securities. Both actions give rise to banks increasing deposit liabilities, as personal and business accounts are credited, coincidental with the depositing of checks or the crediting of accounts. The banking institutions that are in turn dependent on the central bank have balance sheets that can be thought of as an aggregate balance for all of the banking, money-creating institutions comprising the national economy. On the asset side are mainly the reserves (R o ) and bank loans and investments (called "bank credit") (McCallum, 1999 210), and on the liabilities side are mainly a component of the money supply. There are what can be called credit and money multipliers, to refer to the inverse of the fractional relations (i.e., the inverse of R. o to bank credit, and Ro to the deposit liabilities, respectively). These concepts are synonymous with the idea of a fractional reserve banking system.

This is the fractional reserve system with reference to a simplified and consolidated balance sheet for the non-central bank part of the U.S. banking system. Under such a system, reserves (R o ) are some fraction of deposit liabilities (say, one-fifth of check transferable deposits) and a slightly smaller fraction of bank credit (say, one-fourth B. c ). The deposit liabilities are identifiable in the United States as a main component of the money supply since the National Banking Act of 1863, and they are readily substitutable for currency considered as paper notes and coins (Obstfeld & Kenneth 2006). Confronted with an increase in reserves, under the properly functioning fractional reserve system, banks have every inducement to expand bank credit in that it is the major source of income to the banks. The increase in reserves may come about in the United States because of deposits of currency (or gold coins at an earlier date) and/or because of the deposits of checks drawn on the Federal Reserve and used in the purchase of commercial paper and/or government securities by the Federal Reserve.

As bank credit is extended via an increase in loans (or purchases of securities), the recipient of the credit rarely wants the credits to his or her deposit account to hold. A deposit is soon transferred and the bank loan remains on the books. Questions remain about how fast the deposit liabilities get moved around and turned over (the matter of the income-velocity ratio Y/M). These are discussed on various occasions. Further, the process of reserve, bank credit, and deposit creation may go fast, slow, or in reverse. The process of expansion may start in a financial center (say, New York, to continue with open market operations of a special sort) and spread throughout the banking system. There are two reinforcing mechanisms -- those within the banking system and those within the larger financial system. Within the banking system, the reserves may get passed around through trading among banks in reserves (called in the United States trading in federal funds) and through other means, including the sale of securities, mortgages, or loans to other banks. In the larger financial system, a deposit balance for a New York securities dealer (the dealer who sold securities to the New York Fed), may get passed to the hinterland as the dealer replaces the inventory by the purchase of more securities from a firm in the hinterland. Financial markets adjust quite rapidly, even internationally (Walsh, 2005 159). The point, nevertheless, is that important control is exerted through the fraction of reserves supplied by the central bank. This control may be for good, or for evil. It exists, whatever the latter complexities. The general thrust of operations under the historical gold-type mechanism leads to a conclusion: namely, efforts via effective international competition to export goods (as symbolized by -? PU.S. / P UK ) and to obtain gold (or monetary reserves) under fractional reserve banking arrangements raise nominal and/or real income within the time frame of the inflow, and possibly with some lag afterward.

Starting the sequence of events with a more favorable stance with respect to U.S. via-a-vis U.K. prices (-?P U.S. / P UK ) would result in a more favorable balance of trade in the United States. The United States could face greater monetary growth without adverse balance-of-payments consequences. The money growth or inflow of monetary reserves (?R U.S. ) could support the expansion of bank credit and the money stock (?M) and also contribute to the prospect of increased spending and increased income received (?

). There would always be the threatening prospect of relatively higher U.S. prices (?P U.S. / P UK ) (Lohmann, 2004 284). Quite clearly, causation is from money to income (? ). And indeed this process may continue in a money and markets oriented economy. However -- and perhaps not surprisingly for one who reads the lines in the financial press and between them -- all of this balance-of-payments balancing out is not what we encounter in the global economy we come to in the 1990s and upon entry to the twenty-first century. In this new, emerging open-economy world, traditions and practices (including saving to income ratios) vary as we emphasize.

Indeed, there may be a permanent (or quasi-permanent) balance of sorts, exclusive of above and below the line balance in the U.S. balance of international payments. In it Japan appears as a major capital-funds exporting economy in the world and, reversing a century of economic thought, the largest, most developed economy in the world attracts inflows of capital funds (Kydland & Edward, 2004 481). Again reversing the tradition in economic theory, these inflows of capital funds to the United States may come about even with prevailing low interest rates via-a-vis selected Asian economies, Russia, Brazil, and emerging market economies on the average.

Chapter Two

Literature Review

We have drawn distinctions between an essentially i-regime and an M-regime/inflation-rate targeting approach at the national level with roots in Keynes's work and Friedman's respectively. In this interest-rate orientation, as set on a course by Keynes, however, "the interest rate" is the long-term rate (iL), although short-rate control arrangements enter into the Keynes/Keynesian investment and liquidity preference blocks. As pointed out in the i-regime context, these control arrangements are such that direct…[continue]

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