Money and Banking Assignment Example | Topics and Well Written Essays - 1500 words

Money and Banking - Assignment Example The flow of money is not constrained by physical proximity, money flows around the globe through banking institutions and financial markets. This seemingly free flow of money is constrained, however, by rules under which banks and financial markets must operate, as dictated by government policy. This essay will examine different concepts which affect money and banking. I. If the central bank has an interest rate target, why would an increase in the demand for bank reserves lead to a rise in the money supply? If the central bank has an interest rate target an increase in the demand for bank reserves will lead to increase in the money supply since the increase in the demand for reserves shifts the reserves demand curve to the right which in turn would increase the interest rates. In order to prevent this, the central will buy bonds to increase the supply of reserves. The open market purchase will then cause the monetary base and the money supply to expand (Bishop 2012). II. The benefits of central bank lending to banks (rediscount operations) to prevent bank panics are obvious. What are the costs? The benefits of the central bank lending money to banks include helping them to maintain at least a fixed ratio of reserves relative to their to their transaction deposits, they help stabilize the total willingness to hold reserves in the overnight inter-bank loan market. A stable demand of reserves in the overnight inter-bank loan market helps to stabilize the overnight inter-bank loan interest rate, given a quantity of reserves supplied by the central bank. Central banks may lend emergence reserves and other funds when banks have liquidity problems or other financial problems such as shortage of capital. But like deposit insurance, the lending increases moral hazard if the central bank guarantees that all institutions can have access to discount loans, even institutions that are poorly managed. Part of the cost of poor management of