Homework Question on The Role and Influence of Central Banks
- Explain and justify the following statements. Try to provide a modern day example for each case:
- A central bank’s reputation for maintaining currency stability is critical.
- Central bank independence and focus is necessary to avoid political influence.
- Central banks lacking independence must often monetize the deficit NOTE: you can see the powerpoint attached to see what topics are related for these statements.
- NOTE: the modern examples should not be later that 2011
Homework Answer on The Role and Influence of Central Banks
- A central bank’s reputation for maintaining currency stability is critical.
The Central Bank has a central role of determining the stability of a currency. This is critical as it facilitates a stable macroeconomic environment. A stable macroeconomic environment is suitable for achieving stability in the economic growth of a given country. The currency should be stable. It should not be too weak against another foreign currency. For instance, currently the Kenyan shilling fairs weakly against the U.S. dollar led by an influx of cheap imports and a production deficit manufacturing environment.
The Central Bank should come up with favourable fiscal policies to ensure that the currency remains stable. Neither should a country’s currency remain very strong against another foreign currency since it deters foreign investment. Furthermore, it discourages tourists from visiting that particular country which denies the country the much needed foreign exchange. Policies such as an export-oriented economy, security and establishment of an independent agricultural country lead to a stable currency.
The interest rates should be kept stable to ensure the monetary supply does not collapse under huge debts. Additionally, the inflation rates should be kept in check (stable) to ensure the prices of goods and services within an economy is affordable to the general public which ensures political and economic stability (Hellwig, 2014). The Purchasing Power Parity Theory of Exchange Rate is used to determine the value of exchange rate between countries in the event of equality in the purchasing power parities between two countries.