Central Banks

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Central Banks :

A central bank, reserve bank or monetary authority, is an entity responsible for the monetary policy of its country or of its group of member states, such as the European Union. Its primary responsibility is to maintain the stability of the national currency and money supply, but more active duties include controlling subsidized loan interest rates, and acting as a "bailout" lender of last resort to the banking sector during times of financial crisis (private banks often being integral to the national financial system).
It may also have supervisory powers to ensure that banks and other financial institutions do not behave recklessly or fraudulently. A central bank is usually headed by a Governor, President in the case of the European Central Bank or Chief Executive/Managing Director in the case of Hong Kong Monetary Authority and Monetary Authority of Singapore.
In most countries the central bank is state-owned and has a minimal degree of autonomy, which allows for the possibility of government intervening in monetary policy. An "independent central bank" is one which operates under rules designed to prevent political interference; examples include the US Federal Reserve, the Bank of England (since 1997), the Reserve Bank of India (1935), the Bank of Mexico (1993), the Bank of Japan, the Bank of Canada, the Reserve Bank of Australia and the European Central Bank.

Responsibilities :

Containing Inflation :As the rate of inflation rises the prices will start to increase and as a result
spending will increase and as a result the interest rates will increase which will increase the cost of government borrowing. So in order to check prices of goods and to keep the cost of borrowing low the inflation has to be contained. This is sometimes done by tightening the money supply which reduces the spending. One of the ways to reduce money is to increase the interest rates.

Government's banker : As mentioned earlier it is the Government's banker and the bankers' bank ("Lender of Last Resort") .That is it borrows money from the market on the behalf of the government and also it acts as a bank for all the other banks i.e; all the banks borrow money from the central bank and also deposit their excess cash with it.The government’s borrowing are primarily in the form of bonds and guilts.

Government bonds :A government bond is a bond issued by a national government denominated in the country's domestic currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Government bonds are usually considered risk-free bonds, because the government can raise taxes, reduce spending, or simply print more money to redeem the bond at maturity. Investors in sovereign bonds have the additional risk that the issuer is unable to obtain foreign currency to redeem the bonds.
The value of a bond is measured by it's yield

Yield :The yield of a financial instrument/security (finance), usually a debt instrument, or other investment is the rate of return the holder earns on that instrument.The absolute yield levels vary mainly with expectations of inflation. How yields compare between financial instruments tends to depend mainly on the credit worthiness of the lender, and the maturity
of the instrument. The least risky instruments, such as government bonds, virtually always yield less than more risky corporate bonds. The relationship between yields and the maturity of instruments of similar credit worthiness, is described by the yield curve. Long dated instruments typically have a higher yield than short dated instruments.The yield of a debt instrument is generally linked to default probability of the issuer. The more the
default risk, the higher the yield would be in most of the cases since issuers need to offer investors some compensation for the risk.In bond markets, US Treasury bond yields are the benchmark debt instruments because they are backed by the US Government and the risk of default is almost nil. All the other debt instruments' yields are then linked to their default risk.

Gilts : Gilts are bonds issued by the governments of the United Kingdom, South Africa, or Ireland. The term is of British origin, and refers to the debt securities issued by the Bank of England, which had a gilt (or gilded) edge. Hence they are called gilt-edged securities, or gilts for short. Generally, when a market participant refers to gilts, what is meant is British gilts unless otherwise specified, and the description below applies to the UK gilt market.

Managing foreign exchange reserves : Foreign exchange reserves are the foreign currency deposits held by central banks and monetary authorities. These are assets of the central banks which are held in different reserve currencies such as the dollar, euro and yen, and which are used to back its liabilities
e.g. the local currency issued, and the various bank reserves deposited with the central bank, by the government or financial institutions.
In a non fixed exchange rate system, reserves allow a central bank to purchase the issued currency, exchanging its assets to reduce its liability. The purpose of reserves is to allow central banks an additional means to stabilise the issued currency from excessive volatility, and protect the monetary system from shock, such as from currency traders engaged in flipping. High reserves is often seen as a strength, as it indicates the backing a currency has. Low or falling reserves, may be indicative of an imminent bank run on the currency or default, such as in a currency crisis.

Setting the monetary policy : Monetary policy is the government or central bank process of managing money supply to achieve specific goals—such as constraining inflation, maintaining an exchange rate, achieving full employment or economic growth. Monetary policy can involve changing certain interest rates, either directly or indirectly through open market operations, setting reserve requirements, or trading in foreign exchange markets. Monetary policy is generally referred to as either being an expansionary policy, or a contractionary
policy, where an expansionary policy increases the total supply of money in the economy, and a
contractionary policy decreases the total money supply. Expansionary policy is traditionally used to combat unemployment in a recession by lowering interest rates, while contractionary policy has the goal of raising interest rates to combat inflation.The main monetary policy instruments available to central banks are open market operation, bank
reserve requirement, interest-rate policy, re-lending and re-discount (including using the term repurchase market), and credit policy (often coordinated with trade policy). While capital adequacy is even more important, it is defined and regulated by the Bank for International Settlements, and central banks in practice do not apply stricter rules.To enable open market operations, a central bank must hold foreign exchange reserves (usually in the
form of government bonds) and official gold reserves. It will often have some influence over any official or mandated exchange rates: Some exchange rates are managed, some are market based (free float) and many are somewhere in between ("managed float" or "dirty float").

Market Regulation : Small economies with little control over users of their currency, and the US which due to the use of its currency worldwide also has little control, and the EU which can't easily control policies of all national banks, tend to employ open market operations rather than Chinese-style reserve rulings.
Through open market operations, a central bank influences the money supply in an economy directly.
Each time it buys securities, exchanging money for the security, it raises the money supply. Conversely, selling of securities lowers the money supply. Buying of securities thus amounts to printing new money while lowering supply of the specific security.

The main open market operations are:

Temporary lending of money for collateral securities ("Reverse Operations" or " repurchase operations", otherwise known as the "repo" market).
These operations are carried out on a regular basis, where fixed maturity loans (of 1 week and 1 month for the ECB) are auctioned off. Buying or selling securities ("Direct Operations") on ad-hoc basis. Foreign exchange operations such as forex swaps.

Issuing Bank Notes : All the currency notes and coins are issued by a central bank only .

Repo rate/Reverse Repo rate : Repurchase agreements (RPs or Repos) are financial instruments used in the money markets and capital markets. A more accurate and descriptive term is Sale and Repurchase Agreement, since what occurs is that the cash receiver (aka repo seller) sells securities now, in return for cash, to the cash provider (aka repo buyer), and agrees to repurchase those securities from the cash provider for a greater sum of cash at some later date, that greater sum being all of the cash lent and some extra cash (constituting the implicit interest rate, known as the repo rate). There is little that prevents any security from being employed in a repo; so, Treasury or Government bills, corporate and Treasury / Government bonds, and stocks / shares, may all be used as securities involved in a repo.
A Reverse Repo is simply a repurchase agreement as described from the cash provider's perspective, as the cash provider is not the repurchasing party, but the reverse i.e. the party from whom the security is repurchased. Hence, the cash receiver executing the transaction would describe it as a 'repo', while the cash provider in the same transaction would describe themselves as executing a 'reverse repo'. So 'repo' and 'reverse repo' are exactly the same kind of transaction, just described from opposite viewpoints.
A repo is economically similar to a secured loan, with the lender of money receiving securities as
collateral to protect against default. However, the legal title to the securities clearly passes from the seller to the investor. The cash provider is referred to as an "investor" or "buyer"; the provider of the collateral (i.e. the security) is the "seller". Coupons (installment payments that are payable to the owner of the securities) which are paid while the repo buyer (aka cash lender i.e. cash provider) owns the securities are, in fact, usually passed directly onto the repo seller (i.e. cash receiver) which might seem counterintuitive, as the ownership of the collateral technically rests with the cash provider during the repo agreement. It is possible to instead pass on the coupon by altering the cash paid at the end of the agreement, though this is more typical of Sell/Buy Backs.
Although the underlying nature of the transaction is that of a loan, the terminology differs from that used when talking of loans due to the fact that the cash receiver does actually repurchase the legal ownership of the securities from the cash provider at the end of the agreement. So, although the actual effect of the whole transaction is identical to a cash loan, in using the 'repurchase' terminology, the emphasis is placed upon the current legal ownership of the collateral securities by the respective parties.
Repos are typically short-term however it is not unusual to see repos whose maturity is as long as 2years.

Handling the foreign exchange rates : Some central banks tend to control their currency in the forex market by buying and selling foreign currency. This is done primarily to aid exports.

Revaluing currency exchange rate : It means a rise of currency to the relation with a foreign currency in a fixed exchange rate. In floating exchange rate correct term would be appreciation. The antonym of revaluation is devaluation.

Soft currency : Soft currency and hard currency are two forms of money in use around the world.
Soft currency begins initially with nations unable to enjoy the rewards of hard currency without the penalty of inadequate consumption by the poor and inadequate national infrastructure with which to support human and environmental rights, civilized values, and often national defense.
Such poorer nations are condemned to employ other nation's currencies or soft currency of their own.
Once they use soft currency, poorer nations often try to harden it by using soft currency (cheap money) to motivate higher production from year to year and high rates of savings. Savings allow capital investment and more machinery to raise production in a virtuous circle.
In practical terms turning a poor nation into a rich one requires time and expertise in production and governance of both the nation and its economy. There is an ongoing debate over where expertise and decision is best located: Is it in private hands who then produce economic output and manage the money system? Which is to say: Is there a market in which prices, in effect, should make decisions with minimum management by lawmakers and ministries? If market prices lead to economic success and hard currencies that is what will prevail -- that will decide the debate.
If economic failure, in terms of high rates of poverty, unemployment and political discontent prevail in a democracy, government will be compelled to endorse a soft currency regime in hope of future success.
The full description of a successful soft currency regime may be found in the financial experience of America as the arsenal of democracy from 1942 to 1946. But the soft currency that was rapidly hardened by military victory and the destruction of all other economies that normally can compete with America, make the wartime financial regime a controversial plan for use when war is over.
From 1947 until today, America's and the world's use of soft currency to motivate a successful war on want has declined. Rather than make war on want, most of the global economy remains committed to the belief that governments lack the expertise and honesty to manage their political economies better than market forces and market prices.