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Course name Central Banking and Monetary policy

Course No. FIN-421

1. a) Definition of central bank & Describe the main reason for the existence of
central banks.
Answer: A central bank is a bank which constitutes the apex of the monetary and banking
structure of its country and which performs, as best as it can, in the national economic interest.
The aim of the Central Bank is not to earn profit, but to maintain price stability and to strive for
economic development with all round growth of the country. It acts as the leader of the banking
system and money market of the country by regulating money and credit. The main reason for
the existence of central banks is given below:
a. To manage short-term interest rates, particularly the lending rates of banks, and therefore
influence the demand for loans / money creation, called monetary policy.
b. To regulate and supervise the unstable banking (and financial) system.
c. To manage and control the currency System.

b. What are the objectives of financial stability? How is financial stability achieved
Objective of financial stability:
a. Price stability: Price stability is low and stable (non-volatile) changes in the general price
b. Stable conditions in the financial system: Stable conditions in the financial system are
accomplished when there is a high degree of confidence that the financial intermediaries and
markets are stable, i.e. are able to meet obligations without disruption.
How is financial stability achieved domestically? - There are two elements to financial
stability, i.e. stable conditions in the financial sector and price stability. The former is
achieved by the CB putting in place measures and facilities that allows it to:
Ensure the availability of notes and coin in circulation in convenient denominations to
serve as a means to effect financial transactions.
Create an efficient national payments and interbank settlement system.
Support the development of efficient money, bond and foreign exchange markets.
Supervise the financial risks of banks.
Support the development of an efficient banking system.
The other leg of financial stability, price stability, is achieved through the implementation of
sound monetary policies in order to protect the value of the currency.

c. Elucidate the different types of interbank markets.

Answer: The interbank markets are where the settlements of interbank claims take place and
where monetary policy begins. There are following three types of interbank markets:
1. The bank-to-central bank interbank market: It is an administrative market in which
the flow is one-way: from the banks to the central bank in the form of the cash reserve
requirement. In the vast majority of countries the cash reserve requirement balances earn
no interest, which is an essential element in monetary policy. Another important element
of monetary policy in most countries is that banks are kept chronically short of reserves
by the central bank, such that Excess reserves (ER) for the banking system does not exist.
2. The central bank-to-bank interbank market: It is also an administrative market, and
it is at the centre of the vast majority of countries monetary policy. It represents loans
from the central bank to the banks (borrowed reserves). The central bank provides these
reserves at its Key Interest Rate (KIR).
In most countries monetary policy is aimed at ensuring that the banks are indebted
to the central bank at all times so that the KIR is applied and therefore is made effective
on part of the liabilities of the banks. The KIR has a major influence on the banks
deposit rates and, via the more or less static bank margin, on the banks prime rate.
3. The bank-to-bank interbank market: This market operates during the banking day but
particularly at the close of business each day. In the b2b IBM, no new funds are created;
existing funds are merely shifted around and banks place funds with or receive funds
from other banks depending on the outcome of the clearing.

2. a) Central bank is the lender of last resort Explain.

Answer: The Central Bank acts as the lender of last resort and as the bank of rediscount.
Rediscounting can be defined as conversion of bank credit into Central Bank Credit. The
commercial banks approach the Central Bank for its financial needs as it is the lender of the last
resort or the ultimate source of finance. It lends to the commercial banks by rediscounting the
eligible bills. The rediscounting facilities given by the Central Bank impart elasticity and
liquidity to the entire credit structure of the country. It helps the commercial banks in a big way
to prevent them from bank failures.
But its assistance is limited only to the banks which suffer from technical insolvency and
not to those unsound and really insolvent banks. Moreover, unless commercial bank is
conducting its business according to sound banking principles, the Central Bank refuses

The main advantages of the central bank's functioning as the lender of the last resort are:
a. It increases the elasticity and liquidity of the whole credit structure of the economy.
b. It enables the commercial banks to carry on their activities even with their limited cash

c. It provides financial help to the commercial banks in times of emergency.

d. It enables the central bank to exercise its control over banking system of the country.

Thus, the Central Bank is able to control credit while discharging the function of lender of
last resort. The Central Bank is also regarded as performing the function of last resort when it
grants accommodation to the government in times of monetary stringency.

b) Why does central bank keep and manage gold and foreign exchange
The central bank keeps and manages gold and foreign exchange reserve for the following

Central banks are the custodians of the foreign asset reserves of the country. Essentially,
they hold a stock of reserves on behalf of government and the public. In other words they
are required by government to hold sufficient reserves
To intervene, i.e. to sell or buy foreign exchange, in the foreign exchange market in order
to influence the value of the currency.
For transactions purposes. An example is to supply government with forex to enable it to
repay a maturing foreign loan. Another is to be able to supply forex to the market if there
is an unusually large demand for forex in order to prevent a sudden fall in the exchange
Foreign (inward) investments tend to take place in countries that have large and stable
forex reserves.

c) Expound on the significance of the central banks role in public debt

Answer: The public debt is defined as how much a country owes to lenders outside of itself.
These can include individuals, businesses and even other governments. Public debt only refers to
national debt but some countries also include the debt owned by states, provinces and
Public debt management is part of fiscal policy. Fiscal policy and monetary policy coordination is an essential part of economic policy. Apart from this obvious macro relationship,
the central bank (CB) plays a role in micro public debt management, as follows:
The CB acts as an agent for Treasury in the placing of treasury bills and government bonds in the
debt market. It conducts regular (usually weekly) treasury bill tenders as well as other special
tenders of bills when required. It conducts tenders for government bonds when required. Where a

primary dealership system is in place, the CB organises it, appoints the dealers and conducts the
tenders as well. Usually the primary dealers are obliged to tender for a certain minimum amount.
The bonds on offer are allocated in ascending order of yields bid.
The CB participates in Treasurys debt management meetings, and acts an advisor in decisions
on the timing, size, type of security, and the maturity structure of bond issues. It also advises
Treasury in respect of foreign issues of bonds.

3. a) How did Japan develop their economy with the help of their central bank
after the Second World War?
Answer: After Second World War, the Central bank of Japan (Bank of Japan) played a vital role
in the economic development of Japan. In this regard, the bank of Japan adopted the following
1. Financial institutions were classified into the following different categories, with
each category specializing in a specific function.
a. Government financial institutions were founded, including the Japan Development
Bank (in 1951) and the Export-Import Bank of Japan (in 1951). The Long-Term
Credit Bank Law took effect in 1952; it strengthened the function of long-term credit
banks such as the Industrial Bank of Japan.
b. For international businesses, a Foreign Exchange Bank Law became effective in
1954; it categorized the Bank of Tokyo and other authorized foreign exchange banks
as financial institutions specializing in foreign exchange business.
c. Working funds were to be supplied by financial institutions other than those
mentioned above, with major commercial banks (city banks) being the key players.
d. Four key industries (electric power, coal mining, iron and steel, and shipbuilding) and
export-related enterprises were prioritized in money allocations.
2. The Overlending Policy: The demand for funds for key industries or exporting
enterprises centered on city banks. They did not have sufficient deposits or capital of their
own to meet the demand, so the deficit was financed first by borrowing surplus funds
from other financial institutions like regional banks, and ultimately by borrowing from
the Bank of Japan (the overlending phenomenon). For funds for foreign trade, various
types of trade financing backed by the government were available, as for example, the
Bank of Japans rediscounting of trade bills.
3. The Low interest Policy: Financial institutions were in a managerial environment such
that a profit was guaranteed even if they loaned to others at low interest. Specifically:
First, The system was devised to restrict competition among financial institutions. The
domestic and international financial markets were separated from each other.
Second, The Ministry of Finance and the Bank of Japan assigned a credit limit to each
bank through their window guidance and thus cont rolled the total amount of credit
given by all the banks.
Third. There was a ceiling on interest rates. Banks lending rates were linked to and
moved together with the Bank of Japans official discount rate.

Fourth, each financial institution was under the strict control of the Ministry of Finance
concerning financial reports.
4. Finally, the convoy system was adopted. This system aimed at preventing banks from
collapsing and also at preventing the occurrence of credit uncertainty.
In Japans postwar economy, where capital or wealth was in short supply, such a financial system
was an effective tool for economic reconstruction and the high economic growth that followed.

b) Describe the Objectives for the Establishment of Reserve Bank of India (R.B.I).
The main objectives for establishment of RBI as the Central Bank of India are as follows:
To manage the monetary and credit system of the country
To stabilizes internal and external value of rupee.
For balanced and systematic development of banking in the country.
For the development of organized money market in the country.
For proper arrangement of agriculture finance.
For proper arrangement of industrial finance
For proper management of public debts. To establish monetary relations with other
countries of the world and international financial institutions.
For centralization of cash reserves of commercial banks.
To maintain balance between the demand and supply of currency.

C) Point out differencs in case of monetary policy application between Bangladesh

bank and Reserve Bank of India?
Answer: The differences between monetary policy of Bangladesh Bank and monetary policy of Reserve
Bank of India are given below:

Operations of monetary policy of Bangladesh bank: Major instruments of monetary control

available with Bangladesh Bank are given below:
1. Bank rate: Since 1990, this instrument has been put in use to change the cost of
borrowings for banks and thereby to affect the market rate of interest. The present bank
rate in Bangladesh is 6.75%.
2. Open market operations (OMO): OMO allows flexibility in terms of both the amount
and timing of intervention, which did not exist in Bangladesh before 1990. Bangladesh
Bank introduced a 91-day Bangladesh Bank Bill, a market-based tool for monetary
intervention, in December 1990. The bank bill was subsequently withdrawn from the
market. At present, OMO operations are conducted through participation of banks in
monthly or fortnightly/weekly auctions of TREASURY BILLs.
3. Rediscount policy: After the introduction of Financial Sector Reform Program (FSRP),
the refinance facility was replaced by rediscount facility at bank rate to eliminate
discrimination in access to central bank funds. Refinance facility is now available for
agricultural credit provided by BANGLADESH KRISHI BANK and for projects of Bangladesh

Rural Development Board financed by SONALI BANK. Banks are advised to extend credit
considering banker-customer relationship.
4. Statutory reserve requirement: Cash reserve requirement (CRR) of the deposit money
banks has a significant potential to regulate money supply through affecting money
multiplier, while statutory liquidity requirement (SLR) is generally used to affect the
lending capability of the bank. Bangladesh Bank used these two instruments very
infrequently before 1990 and very often after 1990.
Operations of monetary policy of Reserve bank of India: The important function of RBI is to
control money and credit in the country. The instruments of monetary policy operated by the RBI
may be classified into two categories
A. Quantitative credit control
1) Bank rate: - The RBI provides credit to banks by rediscounting eligible bills of exchange
and by making advances against eligible securities such as government securities. The
lending rate for these advances by the RBI is called the BANK RATE which is a traditional
weapon to control money supply.
2) Reserve requirements: - Reserve requirements are used by RBI to control the credit creation
capacity of banks. Every commercial bank needs to maintain a certain proportion of its assets
in the form of reserve. Cash reserve ratio (CRR) and statutory liquidity ratio (SLR) are the
two reserve requirements imposed by the RBI.
3) Open Market Operations: - The RBI can enter the money market for the purpose of
purchase or sale of government securities on its own account. Open market operations are
highly flexible. Easily reversible in time, their effect on money supply is immediate, and they
do not carry announcement effect as in the case of changes in the bank rate.
4) Repo And Reverse Repo Rates - At present, the repo and the reverse repo rates are
becoming important in determining interest rate trends. Repo (sale and repurchase
agreement) is a swap deal involving the immediate sale of securities and simultaneous
purchase of those securities at a future date, at a predetermined price. Such swap deals take
place between the RBI on one hand, and banks and other financial institutions, on the other.
The repo rate helps commercial banks, to acquire funds from the RBI by selling securities
and at the same time agreeing to repurchase them at a later date. Reverse repo rate is just the
opposite of repo rate.
B. Selective or qualitative methods: The RBI has the power to direct banks to meet their
obligation through selective methods of credit control. The following are some of the
selective methods followed by RBI:1) Margin requirements
2) Discriminatory rates of interest
3) Ceiling on credit
4) Direct action
5) Moral Suasion

4. a) The Federal Reserve System resembles the US Constitution in that it was

designed with many checks and balances. Discuss.

Like the U.S. Constitution, the Federal Reserve System, originally established by the Federal
Reserve Act, has many checks and balances and is a peculiarly American institution. The ability
of the 12 regional banks to affect discount policy was viewed as a check on the centralized power
of the Board of Governors, just as states rights are a check on the centralized power of the
federal government. The provision that there be three types of directors (A, B, and C)
representing different groups (professional bankers, businesspeople, and the public) was again
intended to prevent any group from dominating the Fed. The Feds independence of the federal
government and the setting up of the Federal Reserve banks as incorporated institutions were
further intended to restrict government power over the banking industry.

b) Compare the structure and independence of the Federal Reserve System

and the European System of Central Banks.
The Federal Reserve and European System of Central Banks have a similar structure in that there
is an equivalence between the Board of Governors (Fed) and the Executive Board (ECB) and
then the FOMC (Fed) and the Governing Council (ECB). A key difference between the latter
two bodies is that the FOMC has a majority of members as political appointments whereas the
Governing Council has as a majority the heads of central banks.
The ECB has a similar structure regarding independence. Both have instrument independence
and have their high level goals set through legislation/treaty. The ECB might be considered to be
more independent as all countries in the European community have to ratify changes to its
charter whereas the Fed is subject to Congressional changes.

c) The independence of the Fed has meant that it takes the long view and not the
short view. Is this statement true, false or uncertain? Explain your answer.
Uncertain. Although independence may help the Fed take the long view, because its personnel
are not directly affected by the outcome of the next election, the Fed can still be influenced by
political pressure. In addition, the lack of Fed accountability because of its independence may
make the Fed more irresponsible. Thus it is not absolutely clear that the Fed is more far sighted
as a result of its independence.

5. a) Define monetary policy. What are the objectives of monetary policy?

Answer: Monetary policy may be defined as the central banks policy pertaining to the control
of the availability, cost and use of money and credit with the help of monetary measures in order
to influence prices and employment for achieving the objectives of general economic policy.
Monetary policy works through expansion or contraction of investment and consumption
The objectives of monetary policy are given below:

d. Price stability: Price stability is low and stable (non-volatile) changes in the general
price level. Inflation distorts economic calculations and expectations while deflation
creates depression in the economy. Thus price stability should be the main aim of
monetary policy. Price stability promotes business confidence, makes economic
calculation possible, controls business cycle and introduces certainty in economic life.
e. Exchange Stability: Maintenance of stable exchange rates is an essential condition for
the creation of international confidence and promotion of smooth international trade on
the largest scale possible. A restrictive monetary policy trends to reduce a countrys
balance of payment defect in various ways.
f. Full Employment: In under developed countries, the full employment objective is more
crucial, because such economies have both unemployment and under employment open
and disguised. In less developed countries, though full employment cannot be achieved
within a short period, the monetary policy should try to achieve at least a near full
employment situation.
g. Economic Growth: This comparatively a recent object of monetary policy. If refers to
the growth of real income or output per capita. Monetary policy can contribute to
economic growth in the following ways:

It can maintain a balance between monetary demand and supply of goods.

It can create atmosphere in which a higher rate of saving and investment would be
Monetary policy minimizes fluctuation in business activity and prices.
It creates stability for growth.
It influences the rate of interest, investment and the use of credit in the most
productive channels in the economy.

h. Neutrality of Money: Neutrality of money indicates a situation in which changes in the

quantity of money occurs in such a way as to cause a proportionate change in the
equilibrium prices of commodities, and the equilibrium rate of interest remains
unchanged. If money is neutral, an increase or decrease in the quantity of money will
both produce and disturbing effects in the economy.
i. Balance of Payment Equilibrium: Balance of payment equilibrium condition is a
position at which a country repaid its debts and has attained an adequate reserve at zero
balance over time. This main objective on monetary policy has become significant in the
pose-period. It is realized that the existence of balance of payment deficit seriously
reduces the ability of an economy to attain other objectives. So, monetary policy must
make into consideration the international payment problem.

b) Define bank rate & State the effects and limitation of variation of the bank rate
Answer: Bank rate is the rate at which the Central Bank is prepared to rediscount the approved
bills or to lend on eligible paper. By changing this rate the Central Bank control the volume of
credit. The effects of variation of bank rate are given below:
a. Effects on price level: If bank rate increases, cost of credit will increase and the
businessmen will reduce their borrowings from commercial banks. This will reduce
production and increase unemployment in the economy. As a result, income and price

level will go down and depression in business and trade will be the outcome. If there is a
decrease in the bank rate the opposite results of above will be experienced in the economy.
b. Effects on foreign trades: An increase in bank rate wills increases other interest rates in
the country. So, investment will be profitable. It will ensure the insertion of foreign capital
into the economy and leakage of domestic capital will be stopped. Moreover, increased
bank rate will decrease the piece level because amount of credit will be reduced into
country. This decreased price level will again encourage expert and discourage import,
which will make balance of payment favorable. Opposite effects of above will be
experienced if the central bank decreases the bank rate in the economy.
Limitations: The Bank Rate Policy suffers from the following limitations:
a. The rate of interest in money market may not change according to the changes in the
bank rate.
b. In rigid economic system, i.e., planned and regulated economies, the prices and costs may
not change as a result of changes in the rate of interest.
c. The bank rate cannot be the sole regulator of the economic system, and the volume of
savings and investments cannot be controlled through the rate of interest alone.
d. The effect of rise in the bank rate in controlling credit for industrial and commercial
purpose is limited.
e. The change in the methods of financing by the business firms reduces the importance of
bank rate policy.
f. The bank rate policy does not discriminate the activities into productive and unproductive

c) Discuss about the limitations of Monetary Policy in Developing Country like

Answer: In developing country, monetary policy suffers from the following limitations
1. In under developing countries, capital markets are narrow and unorganized. Hence,
the credit control mechanisms like open market operation, bank rate, etc. cannot be
2. A narrow bill market makes the discount rate ineffective.
3. The existence of non-bank financial intermediaries also makes the credit control
measures of the central bank ineffective.
4. In under developed countries, banking habits are also underdeveloped which
hampers the effectiveness of monetary policy seriously.
5. In backward countries, monetary expansion generally leads to increase imports,
unfavorable balance of payments and loss of gold reserve, etc.
6. The role of monetary policy is not compulsive but permissive. This seriously limits
the efficiency of monetary policy in backward countries.

7. In under developed society where liquidity trap is in existence monetary policy

cannot work efficiently.
8. Administrative honesty and firmness are not very rigorous in less developed
countries which reduce the efficiency of monetary policy a policy a lot.
9. Lastly, the lag between the decision about a particular policy and its implementation
also hinders the monetary policy in its success.

6. a) Explain critically the firm required reserve model of monetary policy.

Answer: Under the firm-RR model the reserve requirement is used to curb M3 (bank notes and
coins + bank deposits) growth in a quantitative manner via creating, through OMO purchases, a
desired volume of reserves (ER). Interest rates are free to find their own levels.
The RR comes into play in that as deposits (= money) increase, as a result of new bank loans
extended or the purchase of newly issued securities (= bank loans), the amount of RR to be held
with the CB increases. But, the banks can get the additional reserves required only by borrowing
from the CB.
Where a reserve requirement exists, which applies to bank deposits, there is a fixed relationship
between RR and bank deposits (BD):
RR = BD r
Thus if BD = LCC 100 million and r = 10%, we have:
RR = LCC 100 million 0.1
= LCC 10 million.
This means that the banks cannot supply any further loans unless the CB supplies Borrowed
reserve (BR). So, without the CB supplying BR, the banking system comes to a halt in terms of
new loans, and therefore money creation.
This model can be illustrated as in the following figure:

Once the banks have no excess reserves, they cannot make new loans. Therefore in the case of an
upward shift in the demand for loans (from D1 to D2), interest rates will rise.

b) Describe the firm borrowed reserves model of monetary policy.

Answer: Under the firm-BR model the main operational tool is the central banks lending rate
(KIR-L) to the banks which is made effective by ensuring through OMO a liquidity shortage
(BR) at all times The effective-making of the KIR filters through to the banks prime rate (and
to all other rates and the exchange rate), thus influencing the demand for loans (the main driver
of money creation).
In this model the CB ensures that the banks are indebted to it (the CB) at all times, and whether
the banks have a reserve requirement or not is immaterial. The CB relies entirely on interest rates
to allocate funds, and the CB has absolute control over interest rates. Therefore, in this system
monetary policy is virtually all about the item in the central banks books: loans to banks (BR)
and the KIR that is applied to these loans. The existence of loans to banks is what makes the KIR
effective and influences the banks interest rates on both sides of their balance sheets, and
through their lending rate (PR) the demand for loans.
The CB makes daily and longer forecasts of the items that influence bank liquidity, which impact
on the net reserve balance of the banking system that will reflect on the reserve accounts at the
end of the business days, and then undertake OMO to ensure that the banks are borrowing from
the CB. The KIR is applied to the CB loans to the banks.
c) What are the differences between cambridge cash balance approach and fisher's
transaction approach to the quantity theory of money

Answer: The differences between cambridge cash balance approach and fisher's transaction approach
to the quantity theory of money are given below:

1. Functions of Money:
The two versions emphasize on different functions of money. The Fisherian approach lays
emphasis on the medium of exchange function while the Cambridge approach emphasises the
store of value of function of money.
2. Flow and Stock:
In Fishers approach money is a flow concept while in the Cambridge approach it is a stock
concept. The former relates to a period of time and the latter to a point of time.
3. V and k Different:
The meaning given to the two symbols V and in the two versions is different. In Fishers
equation V refers to the rate of spending and in Robertsons equation refers to the cash
balances which people wish to hold. The former emphasises the transactions velocity of
circulation and the latter the income velocity.
4. Nature of Price Level:
In Fishers equation, P refers to the average price level of all goods and services. But in the
Cambridge equation P refers to the prices of final or consumer goods.
5. Nature of T:
In Fishers version, T refers to the total amount of goods and services exchanged for money,
whereas in the Cambridge version, it refers to the final or consumer goods exchanged for money.
6. Emphasis on Supply and Demand for Money:
Fishers approach emphasises the supply of money, whereas the Cambridge approach emphasises
both the demand for money and the supply of money.
7. Different in Nature:
The two approaches are different in nature. The Fisherian version is mechanistic because it does
not explain how changes in V bring about changes in P. On the other hand, the Cambridge
version is realistic because it studies the psychological factors which influence.

7. a) Identify the main functions of Bangladesh Bank?

Answer: The functions of Bangladesh Bank are given below:
A. General Functions:
1. Bank of Note Issue: The most important function of Bangladesh Bank is that it acts as the
bank of note issue. The privilege of the note issue is the monopoly of the Bangladesh bank.
2. Banker, Agent and Advisor to the Government: The Bangladesh bank functions as a
banker, agent and financial adviser to the government a. As a banker to government, the Bangladesh bank maintains the accounts of
government, receives deposits from government, makes short-term advances to the
government and collects cheques and drafts deposited in the government account.
b. As an Agent to the government, the Bangladesh bank collects taxes and other
payments on behalf of the government.
c. As a financial adviser to the lent, the Bangladesh bank gives advice to the government
on economic, monetary, financial and fiscal matters.
3. Bankers Bank: The Bangladesh bank acts as the bankers' bank in three capacities:
a. custodian of the cash preserves of the commercial banks;
b. as the lender of the last resort; and
c. as clearing agent
In this way, the Bangladesh bank acts as a friend, philosopher and guide to the commercial
4. Custodian of the Foreign Currency Reserves of the Country: The Bangladesh bank also
acts as the custodian of the foreign currency reserves of the country concerned.
5. Lender of the Last Resort: In case the commercial banks are not able to meet their financial
requirements from other sources, they can, as a last resort, approach the central bank for
financial accommodation. The Bangladesh bank provides financial accommodation to the
commercial banks by rediscounting their eligible securities and exchange bills.
6. Central Clearance, Settlement and Transfer: As bankers bank, the Bangladesh bank
keeps the cash balances of all commercial banks. It is easier for member-banks to adjust their
claims against each other in the books of the central bank.
7. Controller of Credit: Probably the most important of all the functions performed by a
Bangladesh bank are that of controlling the credit operations of commercial banks. As
controller of credit, the central bank attempts to influence and control the volume of Bank
credit and also to stabilize business condition in the country.
B. Functions as Government Bank:
1. Maintain government fund and accounts: Bangladesh bank maintains and monitors govt.
fund and reserve on behalf Govt. For this reason central bank is called the custodian of govt.

2. Collection and transfer of money: Bangladesh bank collects govt. revenues from different
sectors and deposit it the account of govt. Besides it transfers money from one place to
another according to directions of govt.
3. Handling of government monetary transaction: Bangladesh bank performs all monetary
transaction of home and abroad on behalf of govt.
4. Supervision of loan: Bangladesh bank not only performs monetary transaction on behalf of
govt. but also sanctions supervising of loans of different ministry, department and institution
of govt.
5. Maintaining relation with foreign bank: As an agent of govt. central banks maintain
relationship with central banks of different countries, World Bank (WB), International
Monetary Fund (IMF), Regional Development bank (i.e. ADB), different development
agencies etc.
6. Implementation of government monetary policy: Central bank influences the economy
through monetary policy.
C. Other Functions:
1. Economic research:
2. Development of banking system
3. Development of foreign trade.
4. Improving the quality of economic plan.
5. Development of natural resources.

b) Expound the Frameworks of Bangladeshs Monetary Policy

Answer: The framework of Bangladeshs monetary policy is given below:
1. The Policy Target(s): The appropriate monetary policy strategy in the Bangladesh
context would be to achieve the goal of price stability with the highest sustainable output
growth. Any monetary stimulus to promote growth must keep in perspective the broader
goal of macroeconomic stability, which is a prerequisite for future growth. Price stability
would also include the stability of the currency regime. While fiscal policy too is
relevant in addressing these goals and thus there is a need for policy coordination,
monetary policy must play its due role.
While leading central banks in the industrial world have increasingly adopted the unitary
goal of fighting inflation, interestingly directive by enumerating
The promotion of price stability,
Ensuring full employment,
Supporting global economic and financial stability as the chief monetary policy
2. Inflation Target: It is the general wisdom that monetary policy tools are of immediate
influence in controlling inflation. However contemporary evidence amply illustrates that
monetary policy cannot deal well with the inflationary impact of external shocks such as
the recent international price of oil and related energy products. Many central banks as a
consequence focus on the core inflation, which is typically constructed by subtracting the
most volatile components from the consumer price index (CPI). While there is no

standard measure of core inflation in the Bangladesh context at this time, the construction
methodology is made complex by two facts.
First is that food items constitute nearly 60 percent of the CPI index.
Secondly, in the Bangladesh context, the volatility of the international energy prices
appear not to filter down to the CPI since the relevant domestic prices are subsidized by
the state.
3. Growth target: GDP growth projections of the Medium Term Macroeconomic
Framework (MTMF) in the government's National Strategy for Accelerated Poverty
Reduction (NSAPR), modified appropriately in the light of unfolding actual
developments, are used as output growth targets for the purpose of monetary policies.

c) Who are the main participants in the money market?

Answer: Money market participants include mainly credit institutions and other financial
intermediaries, governments, as well as individuals (households).
1. Government: Still the main participant in the money market is Government. Generally
the central bank (Bangladesh Bank), on behalf of government, takes part in the money
market. Bangladesh Bank issues money market securities such as treasury bills and uses
the proceeds to finance state budget deficits. The government debt is often refinanced by
issuing new securities to pay off old debt, which matures. Thus it manages to finance
long-term needs through money market securities with short-term maturities. Bangladesh
bank also uses repo, reverse repo as instruments of money market to control the money
Supply in the economy.
2. Commercial Banks: Commercial banks account for the largest share of the money
market. They issue money market securities to finance loans to households and
corporations. They mainly buy Government securities, sell certificates of deposit and
make short-term loans, offer individual investors accounts that invest in the money
market. Besides, these Institutions rely on the money market for the management of their
short-term liquidity positions and for the fulfillment of their minimum reserve
3. Non-Bank Financial Institutions (NBFI): A non-bank financial institution (NBFI) is a
financial institution that does not have a full banking license and cannot accept deposits
from the public. However, NBFIs do facilitate alternative financial services, such as
investment (both collective and individual), risk pooling, financial consulting, brokering,
money transmission, and check cashing. Examples of nonbank financial institutions
include leasing companies, mortgage companies, insurance companies, saving banks,
pension funds, investment companies, investment trusts, security dealer/brokers, pawn
shops, central provident fund (CPF), post office saving banks, discount houses, securities
companies, fund managers, venture capital companies, stock exchanges, and factoring
4. Individuals: Ultimate lenders in the money markets are households and companies with
a financial surplus which they want to lend, while ultimate borrowers are companies and





government with a financial deficit which need to borrow. Ultimate lenders and
borrowers usually do not participate directly in the markets. As a rule they deal through
an intermediary, who performs functions of broker, dealer or investment banker.
Businesses: Businesses raise funds in the money market primarily by issuing commercial
paper, which is a short-term unsecured promissory note. In recent years an increasing
number of firms have gained access to this market, and commercial paper has grown at a
rapid pace. Business enterprisesgenerally those involved in international tradealso
raise funds in the money market through bankers acceptances (A time draft drawn on
and accepted by a bank).
Money Market Mutual Funds: A Money Market Mutual Fund includes short-term, lowrisk securities and generally allows small investors to participate in the money market by
aggregating their funds to invest in large-denomination money market securities.
Formally, money market mutual funds are investment funds that are pooled and managed
by firms that specialize in investing money for others for the purpose of investing in
short-term financial assets.
Pension funds: Pension funds are retirement plans funded by corporations or
government agencies for their workers and administered primarily by the trust
departments of commercial banks or by life insurance companies. It maintains funds in
money market instruments in readiness for investment in bonds, stocks, mortgages, and
real estate.
Insurance Companies: The largest type of financial intermediary handling individual
savings. Receives premium payments and places these funds in loans or investments to
cover future benefit payments. Lends funds to individuals, businesses, and governments
or channels them through the financial markets. It maintains liquidity needed to meet
unexpected demands.