Question

What FUNCTIONS do Central Banks perform in a market-oriented economy? Explain why each function you have listed is important in the functioning of a market-oriented economic system? Which of these functions is the most important? 1) a) What are the principal goals that Central Banks pursue as they work to carry out monetary policy? b) In what ways are commercial banks of special importance to the functioning of the money and capital markets and the economy? c) The name COMMERCIAL in commercial banking, what does it imply? d)

Answer 1

1. a) The Central Bank aims at promoting financial and economic stability in the country. It supervises, controls and regulates the activities of all commercial banks and other financial institutions of the country. The main function of central bank is to control, regulate and stabilize the monetary system of the country. The functions of central bank in market oriented economy are:

Controller of credit - important function of central bank is the controller of credit. It is necessary that the supply of credit and use of credit should be in appropriate amount and direction. For this purpose, it uses various credit control measures such as bank rates,open market operations etc. Custodian of foreign exchange reserves - it is required to maintain reserves like gold, silver and foreign exchange to back the issue of currency notes and to meet international payments. Clearing house - central bank acts as clearing house for transfers and settlement of mutual claims of the commercial banks. As it keeps the cash reserves of all commercial banks, it is easy for commercial banks to settle each other's debts.   Banker's bank - the activities of all commercial banks are controlled by central bank. The regulation of bank may be related to their licensing, branch expansion, liquidity of assests etc. Central Bank also gives credit to the commercial banks by discounting of bills and advances money on various securities.     

b) The principal goals that central bank pursue as they work to carry out monetary policy are:      Price stability - the fluctuations in the prices causes disturbances in the economy and have serious consequences. The Central Bank, by regulating the supply credit in accordance with the needs of the people, can bring stability. Exchange rate stability - instability in exchange rates is harmful for the foreign trade of a country. Thus the central bank can stabilize the exchange rate by controlling bank credit.   Full employment - unemployment is socially and economically undesirable. Therefore economic stability with full employment and high per capita income has been considered as an important objective of central bank. To achieve full employment cheap money policy has to be followed.       Neutral monetary policy - the objective of central bank is to stabilization of money market so as to reduce the fluctuations in the interest rates. Equilibrium in the demand and supply of money should be achieved at all the times. c) commercial banks importance to the functioning of the money and capital markets and the economy are as under:

• ensuring an adequate flow of credit to the productive sectors,
• sustaining a moderate structure of interest rates to encourage investments,
• creation of an efficient market for government securities.

d) Commercial bank is a type of bank which accepts deposits and makes business loans that operates as business for profit.