Functions of the central bank

• Issues notes and coins
• Financial Stability
  • Regulate the financial market
• Inflation Targeting
  • Base rate
• Banker for the government - handles tax receipts and some items of government expenditure
• Commercial banks hold reserves at the central bank
  • Store of liquid assets used to balance out day-to-day transactions between banks. Decided each month in advance
• Manages the exchange rate
• Quantitative Easing
• Lender of Last resort

Lender of last resort

The Bank of England will lend to banks if there are no other banks willing to lend money, and they are short of cash.

Advantages

• Prevents systemic risk
  • Reduces risk of bank failing and creating domino effect
• Increased financial stability
• Increases confidence in financial system
  • Consumer spending and investment increases, AD increases
• Firms' and Consumers' savings are protected
• Banks able to seek more profit - Increases AD
• Encourages B.O.E to use multiple tools such as regulation to control the market.

Disadvantages

• Banks likely to take bigger risks
  • Larger moral hazard
• Banks encourages to be less liquid
• Reactive - larger opp. cost.

Judgement

Needs to be used in combination with other factors:

• Stress tests
• Regulation
• Reserves