Financial Institutions and Policy

Financial Institutions and Policy

Assignment 2

Instructions: Attempt the following exercises

Exercise 1: Justify your answers

Compare the roles of the national central banks in the European monetary zone and the regional reserve banks in the United States Why is independence important in the central bank business? Should a central bank be independent? Define independence of a central bank according to the authors of the textbook. Are the following three central banks independent: US Federal Reserve Bank, Canada’s Bank of Canada, and the European System of Central Banks, including ECB?  How do you reconcile independence and accountability? If a central bank pushes its economy into an expansion and then into a recession because it wants to reduce or keep the inflation rate within a certain band, how can it be accountable and should it be independent?

   Exercise 2

The Bank of Canada claims that its mission is to target an inflation rate of 2% and keep the actual inflation rate within 2-percentage points band centred on its target inflation rate. Yet it also asserts that it has a target interest rate around 1% that varies over time and it seeks to keep the actual overnight rate within 50 basis points band around its target overnight rate. How can the Bank of Canada achieve two clearly different targets at the same time? Does the fact that the Federal Reserve Board, the ECB, and the Bank of Canada have recently bailed out many large banks and governments who otherwise could have gone insolvent mean that the three central banks’ control of the overnight rates is sufficient to achieve their objectives? The money multiplier relating the money supply to the monetary base declined significantly during the 1929-1933 depression and again during the recent financial crisis of 2008-2010 financial crisis. Yet the money supply M1 decreased by 25% during the 1929-1933 depression but it did not decrease during the 2008-2010 financial crisis. What could possibly explain the difference? (Read chapter16 of Mishkin and Sterlitis)