CHAPTER

Monetary Policy
&
Central Bank

Central Bank of Bangladesh:

The most important players in financial markets throughout the
world are Central Banks- the Government authorities in charge of
monetary policy.
Central Banks action affect
1. Interest rate,
2. the amount of credit,
3. and the money supply, all of which effect on
Financial Market as well as on aggregate output and inflation

Central Bank of Bangladesh:

After the liberation war, and the eventual independence of Bangladesh, the
Government of Bangladesh reorganized the Dhaka branch of the State Bank of
Pakistan as the central bank of the country, and named it Bangladesh Bank.
This reorganization was done pursuant to Bangladesh Bank Order, 1972, and
the Bangladesh Bank came into existence with retrospective effect from 16
December 1971.
At present it has nine offices located at Motijheel, Sadarghat, Chittagong,
Khulna, Bogra, Rajshahi, Sylhet, Barisal and Rangpur in Bangladesh; total
manpower stood at 5071 (officials 3914, subordinate staff 1157) as of end FY
2010.

Central Bank of Bangladesh:

Functions:
The major functional areas include : Formulation and implementation of
monetary and credit policies.
1.Regulation and supervision of banks and non-bank financial institutions,
promotion and development of domestic financial markets. Lender of the
Last Resort.
2.Management of the country's international reserves.
3.Issuance of currency notes- like most of the central banks of different
countries, exercising monopoly over the issue of currency and the banknotes.
Except for the 1 and 2 taka notes, it issues all other denominations of
Bangladeshi Taka.
4.Regulation and supervision of the payment system.

Central Bank of Bangladesh:

Functions:
1.Acting as banker to the government 2.Money Laundering Prevention.
3.Collection and furnishing of credit information.
4.Implementation of the Foreign exchange regulation Act.
5.Managing a Deposit Insurance Scheme .

Central Bank of Bangladesh:

Objectives:
1.Formulating monetary and credit policies;
2.Managing currency issue and regulating payment system;
3.Managing foreign exchange reserves and regulating the foreign exchange
market;
4.Regulating and supervising banks and financial institutions, and advising the
government on interactions and impacts of fiscal, monetary and
other economic policies.

Central Bank of Bangladesh:

Objectives:
1.Formulating monetary and credit policies;
2.Managing currency issue and regulating payment system;
3.Managing foreign exchange reserves and regulating the foreign exchange
market;
4.Regulating and supervising banks and financial institutions, and advising the
government on interactions and impacts of fiscal, monetary and
other economic policies.

Central Bank of Bangladesh and Monetary

policy:
Monetary Policy
the policy adopted by the central bank for control of the supply of money as an
instrument for achieving the objectives of general economic policy.
Monetary Policy refers to all those policy guidelines and supportive money
supply related mechanism that are used by the central banks to maintain money
supply at desired volume so that level of a countrys economic activities remain
pacified.

Money
Generally Money is any accepted means
of payment for delivery
of goods, receipt of services and
settlement of debt.
Functions of Money:
A means of payment for goods and
services and settlement of debt.
Unit of measurement of value and basis
of pricing goods and services.
Store of value over time, but subject to
inflation erosion.
Means of deferred payments.

Money

Characteristics of
Money
Portability
Divisibility
Durability
Stability

Functions of
Money
Medium

of
Exchange
Store of Value
Unit of Account

Monetary Aggregates
Narrow definitions of money include items
that can be spend directly (cash, current
accounts).
Broad definitions of money include items that
cannot be spent directly but can be readily
converted into cash.

Monetary Aggregates
1.

Monetary Base: Currency in circulation

2.

M1 Money Supply

3.

Currency plus demand deposits

M2 Money Supply

4.

Currency and coins plus total reserves

M1 plus short-term time deposits

M3 Money Supply

M2 plus long-term time deposits

General versus Selective Credit Controls

General credit controls affect the entire
banking and financial system.
Examples: reserve requirements, the discount
rate, open market operations
Selective credit controls affect specific groups
or sectors of the financial system.
Examples: moral suasion, margin
requirements on the purchase of
listed securities

Instruments of monetary policy:

Open market operations:

interest rates
monetary base
Reserve requirements
Discount window lending

Instruments of monetary policy:

Open market operations:

A relatively fine tool that can be used to make small
adjustments. These adjustments can be daily and often occur
without much fanfare.
Targeted Interest Rates
A relatively blunt tool that can be used to make large
adjustments. In typical years, changes in targeted interest
rates a few times per year.
Reserve Ratio
A rather blunt tool that is only used when very large
adjustments are in order.

Open Market Operations

Buying Treasury securities:

When the Central Bank purchases securities through the

government securities dealers,
the account balances of the dealers are credited with the
amount
the total amount of fund at the dealers bank increases
Increased money supply.
Central
Bank buys
securities

Central
bank

Securities

Dealer

Reserves

Dealers
bank

Open Market Operations

Selling

Treasury securities

When the Central Bank sells securities (obtained from

previous purchases) to the government securities dealers,

the account balances of the dealers are debited with the
amount
the total amount of fund at the dealers bank reduces by
the market value of the securities
Reduced money supply growth.

Central
Bank buys
securities

Central
bank

Securities

Dealer

Reserves

Dealers
bank

Types of Central Bank Open Market

Transactions
RP or Reverse RP Transaction
(temporary change in the level of reserves held by depository
institutions)
RP: Central Bank buys
securities temporarily
Securities
Central
bank

Reserves
Later on:
Reserves

Dealer
Dealers
bank

Securities returned

Reverse RP: Central Bank sells

securities temporarily
Securities
Central
bank

Reserves
Later on:
Reserves

Dealer
Dealers
bank

Securities returned

Reserve Requirements
When a bank takes a deposit into an account on which a check
can be written, it must place a percentage of that deposit on
reserve at a Federal Reserve bank. That percentage is called
the reserve ratio.

RR raised

banks reduce lending

RR lowered -

banks increase lending

Reserve Requirements

An increase in deposit reserve requirements

decreases the deposit and money multipliers,
slowing the growth of money, deposits and loans
reduces the amount of excess legal reserves institutions deficient in required legal reserves
will have to sell securities, cut back on loans, or
borrow reserves
increases interest rates, particularly in the money
market, as depository institutions scramble to
cover any reserve deficiencies

The Discount Rate

The discount rate is the annual percentage
interest charge levied against those institutions
choosing to borrow reserves from the discount
window of the Central Bank.
Frequent borrowing is discouraged and may
be penalized with a higher interest rate.

The Discount Rate

An increase in the discount rate

reduces the volume of loans from the discount
window (cost effect)
makes borrowing from the Fed less attractive
(substitution effect)
signals that the Fed is pushing for tighter credit
conditions (announcement effect), and market
participants may respond by curtailing their
spending plans or by accelerating their borrowings
(to secure the credit they need before interest rates
move even higher - negative psychological effect)

Monetary Policy

If the Central Bank wants to expand the economy it can

buy bonds
decrease the Discount Rate
lower the reserve ratio.
This increases the supply of loanable funds. This lowers
interest rates which increases aggregate demand.

If the central bank wants to contract the economy it can

sell bonds
increase the Discount Rate
raise the reserve ratio.
This decreases the supply of loanable funds. This raises
interest rates which decreases aggregate demand.