Modern Banking

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Government Debt Placement
If a central bank has this responsibility, it is expected to place government debt on the most favourable terms possible. Essentially, a government can instruct the central bank to raise seigniorage income43 through a variety of methods, which include a reserve ratio (requiring banks to set aside a certain percentage of their deposits as non-interestearning reserves held at the central bank – an implicit tax), interest ceilings, issuing new currency at a rate of exchange that effectively lowers the value of old notes, subsidising loans to state owned enterprises and/or allowing bankrupt state firms that have defaulted (or failed to make interest payments) on their loans to continue operating. Or, the inflationary consequences of an ongoing liberal monetary policy will reduce the real value of government debt.

This third objective is important in emerging markets, but by the close of the 20th century has become less critical than the other two functions in the industrialised world, where policies to control government spending means there is less government debt to place. A notable recent exception is Japan, where the debt to GDP ratio is 145 and rising (2002 figures). In emerging markets, central banks are usually expected to fulfil all three objectives – ensuring financial and price stability, and assisting the government in the management of a sizeable government debt. While all three are critical for the development of an efficient financial system, the central banks of these countries face an immense task, which they are normally poorly equipped to complete because of inferior technology and chronic shortages of well-trained staff.

The Bank of England had a long tradition of assuming responsibility for all three functions, but in 1997 the Chancellor of the Exchequer announced the imminent separation of thethree functions, leaving the Bank of England with responsibility over monetary policy the FSA44 regulates financial...
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