Monopoly Power Over Money

During the cold war, Russian leaders’ every word was scrutinised by an army of Kremlinologists. Now, the honor is accorded to the world’s central bankers, whose pronouncements are pored over by throngs of well-paid financial analysts.

These days, central bankers seem all powerful. In most rich countries they go about their business without interference from politicians. And their success at using their new-found independence to bring down inflation has earned them great respect.

Cental banks matter to the financial system for two main reasons. First, thet set short-term interest rates. These affect the cost of borrowing throughout the economy, from money markets to mortgage rates, and they have an additional influence through their impact on exchange rates, inflation and growth. Second, central banks generally support (and often regulate) the banking system, notably by acting as a lender of last resort to banks in financial distress.

For all central banks’ importance, they remain tiny participants in huge financial markets. So how do they affect prices, i.e., interest rates, in those markets? The reason is that the Fed has a monopoly on supplying bank reserves. Banks are required to hold a fraction of the money deposited with them in a reserve account at the Fed. They usually hold more, for precautionary reasons. The interest rate at which banks’ demand for reserves matches the Fed’s supply is known as the federal funds rate; this is also the rate at which banks lend reserves to each other overnight. The Fed controls it by changing the supply of reserves through sales and purchases of government securities, known as open-market operations.

When the Fed wants to raise the federal funds rate, it sells government securities. And when the Fed wants to lower the rate, it buys securities, which increases banks’ reserves and bids down interest rates.Changes in the federal funds rate ripple through financial markets and the economy. They have knock-off effects on the interest rates at which banks lend to households and firms, and hence the amount of credit in the economy. And they influence long-term market interest rates too.

The Fed can also influence the federal funds rate indirectly, by changing the discount rate, the rate at which it will lend reserves to banks. Raising the discount rate makes it less attractive for banks to borrow reserves. This reduces the volume of reserves, which pushes up the federal funds rate.

Most central banks set monetary policy with the aim of keeping inflation low. The Fed also has a duty to support employment and economic growth. To meet their aims, central banks usually adopt intermediate targets as well. These guide policy, as well as keeping expectations of inflation low. One option is to target money-supply growth, but the historical relationship between money-supply growth and inflation broke down, partly because financial deregulation and innovation made the demand for money unpredictable.

A country with a poor record of controlling inflation can peg its currency to that of a low-inflation economy. In effect, this allows it to piggy-back on the low-inflation ciuntry’s credible monetary policies. But with freely mobile international capital movements, exchange-rate pegs have become vulnerable to speculative attack. So now most rich countries either have permanently fixed exchange rates, as in the euro area, or they have floating rates and control inflation in other ways.

Some economists argue that inflation targets focus too narrowly on consumer-price inflation, which may lead central banks to ignore potentially harmful asset-price bubbles. In Japan in the late 1980’s, the Bank of Japan failed to check soaring shares and property prices, because consumer-price inflation remained low. When the bubble burst, the economy plunged into recession.

Central banks’ monopoly on supplying cash and bank reserves is realtively new. In the19^th century, private banks in Britain and America issued competing currencies. A return to such a “free-banking” era seems unlikely, but even if central banks’ monopoly is not in danger, it may eventually become irrelevant. Privately issued electronic money could one day complicate or even nullify central banks’ ability to set interest rates. Central banks are not about to vanish overnight. But, like the Kremlin, they may not retain their pre-eminence forever.

The Economist

Notes

1. Kremlinologist –политолог, специалист по России, владеющий подробнойинформацией о ее политическом, экономическом положении, ее руководителях и других сферах жизни; во времена Советсокого Союза такие специалисты назывались советологами
2. for all their importance –see Krasnov ex.24, page 76
3. piggy-back (from pick-a-back) –to carry somebody pick-a-back – нести кого-нибудь на спине, на закорках; to piggy-back – здесь: выгодно использовать

Vocabulary

a lender of last resort –кредитор последней инстанции: центральный банк вего функции по поддержанию ликвидности и стабильности банковскойсистемы; он обязуется учитывать векселя и предоставлять кредит коммерческим банкам по официальной учетной ставке

money market –денежный рынок: рынок краткосрочных долговых инструментов (ссудно-заемные операции)

financial market –финансовый рынок :рынок капитала, денежный рынок, где происходит обмен деньгами, предоставление кредита и мобилизация капитала, спекуляции или страхование рисков

bank reserves –банковские золото-валютные резервы; to supply bank reserves – создавать банковские резервы; to monitor bank reserves – следить за объемом банковских резервов

reserve account – резервный счет, который коммерческий банк держит в центральном банке для соблюдения резервных требований, а также для проведения расчетов с другими банками

open market – открытый рынок, где могут торговать все желающие, а цены определяются спросом и предложением

overnight (transaction) – сделка “овернайт” на срок до начала следующего рабочего дня (а если в конце недели, то с пятницы до понедельника)

discount rate - учетная ставка: ставка, по которой центральный банк готов учитывать и переучитывать первоклассные векселя или предоставлять кредиты коммерческим банкам под обеспечение векселями; инструмент денежно-кредитной политики, в значительной степени определяющий общий уровень процентных ставок

money supply –объем денежной массы в обращении; money supply target –ориентир роста денежной массы в обращении, официально установленный властями в рамках денежно-кредитной политики

to peg one’s currency to that of another economy –привязать национальную валюту к валюте другой страны

free banking –а) банковская система без центрального банка, когда все банки имеют право выпускать свои банкноты, обеспеченные золотом б) нерегули-руемая банковская деятельность

electronic money –электронные деньги, используемые в Электронной денежной системе (EMS), системе электронных платежей на базе банковских карточек со встроенными микропроцессорами, работает на основе компьютерных сетей