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Subject 1. Role of Central Banks PDF Download

The Functions of Money

Money performs three basic functions.

  • It serves as a medium of exchange to buy and sell goods and services. Money simplifies and reduces the costs of transactions.

    In the absence of money, a barter economy would exist. Acquiring a belt, for example, would entail finding a belt maker who happened to want what you had to offer in exchange, making transactions tedious, enormously costly, and inefficient.

    Money permits us to realize the enormous gains from the specialization, division of labor, and mass-production processes that underlie our modern standard living.

  • It is used as an accounting unit to compare the value and cost of things. As a unit of measurement, like a centimeter, money is used by people to post prices and keep track of revenues and costs.

  • It provides a way of storing value to allow the movement of purchasing power from one period to another. Although it is not the only way of storing value, it is the most liquid of all assets, due to its function as the medium of exchange. However, many methods of holding money do not yield an interest return and the purchase power of money will decline during a time of inflation.

The Roles of Central Banks

Central banks all have similar roles:

  • Issue currency
  • The government's bank, and bank of the banks
  • Lender of last resort to the banking sector
  • Regulator and supervisor of the payments system
  • Set monetary policy
  • Regulate banking system

A nation's monetary policy objectives and the framework for setting and achieving those objectives stems from the relationship between the central bank and the government. Central banks in different countries have a variety of objectives, such as maximum employment, stable prices, and moderate long-term interest rates. In the long run, these objectives are in harmony and reinforce each other, but in the short run, they might be in conflict.

The key objective is price stability. It is the source of maximum employment and moderate long-term interest rates.

User Contributed Comments 4

User Comment
oneashok Central bank is the lender of last resort to bankers... Is this the conventional function of Central Bank???
CFAToad Oneashok, this may answer your question.

The central bank serves to ensure deposits are secured against shocks in the system. Without a lender of last resort, deposits would require greater interest rates, leading to less market liquidity and fewer financial services. Remember banks first and primary function is to take deposits and issue loans. If the deposit risk raises the cost of the bank to take a deposit, then the loan would require a higher rate as well. And this would apply to all banking services.

This is traditionally a function of a central bank. So yes to your question.
LCMilkbone great in depth summary.
sshetty2 surprised no mention of FDIC here
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I am using your study notes and I know of at least 5 other friends of mine who used it and passed the exam last Dec. Keep up your great work!
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