Finance & Accounting
Pages 20 (5020 words)
Today every central bank around the world creates money, controls monetary policy and provides loans to the commercial system and supervises it (Cechetti & Schoenholtz, 2011, Chapter 15). In times of need, the central bank’s duty is to save the financial system. …
This paper deals with central bank objectives, instruments and theory behind them. Five objectives of central banks will be described and discussed. Central banks’ objectives are price stability, stable real growth, financial stability, and interest rate and exchange stability. Then, direct and indirect tools of monetary policy will be described and discussed. Direct tools affect directly the economic agents (Alexander et al., 1996, p.14). Indirect tools affect bank reserves (Alexander et al., 1996, p.14). Direct instruments are: interest rate controls, credit ceilings, and directed lending to the authorities (Alexander et al., 1996, p.14). Indirect instruments are open market operations, reserve requirements, and central bank lending facilities (Alexander et al., 1996, p.14). Advantages and disadvantages of both will be discussed. It will be described how the central banks control the economy through money supply and how price stability is related to other objectives of central banks, but only as long as money supply can be controlled by the central bank. Finally, United Arab Emirates (UAE) will be shortly analyzed and the performance of their central bank will be discussed. It will be shown that the central bank of UAE’s focus is on exchange rate and economic stability. Since the UAE dirham is pegged to the US dollar, inflation cannot be controlled by the central bank of UAE as its monetary policy is restrained by the peg. Instead, it depends on the inflation in the USA, since the USA is free to adjust its monetary policy. ...