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Exchange Rate Regimes: the Central Bank Essay Example

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Exchange Rate Regimes: the Central Bank

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Exchange Rate Regimes: the Central Bank. Poor management causes inefficient banking systems, and if the collapse of such banks is prevented through rediscount operations, then the cost of losing essential financial resources is inevitable.The second cost of the rediscounting operations is that it causes negative signal conveyed about the back to other banks, investors and liquidators. If these groups of stakeholders realize that the bank has borrowed from the central bank to avoid bank panic, they lack trust in the bank, causing confidence and support for the bank to decline significantly (Mishkin, 2007). The bank may lose its customers and investors, causing financial losses that would be provided by the lost customers and investors. This fear of banks that they may create a negative signal for borrowing from the central bank is referred to as stigma.

Compare the use of open-market-operations, central bank lending facilities (rediscounting), and changes in reserve requirements to control the money supply on the following criteria: flexibility, reversibility, effectiveness, and speed of implementation.Open Market Operations is the most powerful and the most flexible tool of Federal Reserve used to control money supply. It enables the central the Central Bank to adjust the level of reserve balances in the financial market in order to offset seasonal, cyclical or permanent shifts in reserve balances’ supply and affecting the short-term interest rates (Mishkin, 2007). The Open Market Operations is also the most effective tool because it influences the level of reserve balances directly. OMO is easily reversible because a temporary purchase in open market operations can be reversed, especially if the central bank makes a mistake in conducting an OMO. If the central bank realizes that it has made too many purchases leading to a low federal funds rate, it can easily correct that by conducting new open market sales (Mishkin, 2007). OMO can also be quickly implemented because there are no administrative delays.The discount lending is not as effective as open market operations but its effectiveness depends on whether the demand curve cuts the supply curve at the in the vertical section rather than the flat section (Mishkin, 2007). It is effective because it helps in bank panic, but its effectiveness is affected by the costs involved, including helping banks with management problems. Exchange Rate Regimes: the Central Bank.

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References

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Carbaugh, R. 2012. International Economics. Cengage Learning.

Fischer, S. 2001. “Exchange rate regimes: is the bipolar view correct?” Journal of Economic Perspectives, Vol. 15, pp. 3-24.

Mishkin, F., 2007. “Everything You Wanted to Know about Monetary Policy Strategy, but Were Afraid to Ask”, in F. Mishkin, Monetary Policy Strategy. MIT Press, Massachusetts.

Ricci, L.A. 2008. “A Model of an Optimum Currency Area”, Economics: the Open-Access, Open-Assessment E-Journal, Vol. 2, No. 8, pp. 1–31.

Rodrik, D. 2006. “The social cost of foreign exchange reserves”, International Economic Journal, Vol. 20, no. 3, pp. 253-266.

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