UMEDVG-30-3 Top Up Contemporary Issues in Banking and Finance

Part A: You MUST answer this question.

Question 1

One of the key Western responses to Russia’s invasion of the Ukraine were financial sanctions. These financial sanctions include the freezing of more than 50% of the Russian central bank’s international currency reserves and closing off many other means for the Russian financial system to get dollars, euros, pounds, and other foreign currencies.

a) Assume that the banks in Russia have payments to make in foreign currencies and that they get access to these currencies by exchanging rubles (the local Russian currency) for foreign currency at the central bank. Contrast the situation of the Russian central bank under sanctions with the situation in a financial crisis of a central bank (such as the Bank of England) that receives a central bank swap in order to support domestic British banks that have dollar liabilities. Use stylized balance sheets to show

(i) how central bank swaps can be used to support a foreign banking system and

(ii) how the sanctions imposed on the Russian central bank can have an adverse effect on Russian banks. (12 marks)

b) Based on your understanding of financial globalization, will it be only the Russian economy and people who bear the cost of the sanctions? Explain your answer. (9 marks)

c) These sanctions prevent the Russian central bank from accessing assets that it owns. Discuss the ethics of using sanctions to freeze a central bank’s international currency reserves. Be sure to include in your answer a discussion of both sides of the question. (9 marks)

Part B: Choose TWO of the following questions

Question 2

a) Does the central bank control the quantity of reserves available to banks? Please either explain how the central bank exercises this control or why it cannot exercise this control. (10 marks)

b) Does the central bank control the quantity of money in the economy? Please either explain how the central bank exercises this control or why it cannot exercise this control. (10 marks)

c) Central bank digital currencies are an active research agenda for central banks. Discuss the pros and cons of a central bank choosing to use the blockchain technology for a central bank digital currency. (15 marks)

Question 3

a) What New-Keynesian ideas are incorporated into the New Consensus model, allowing monetary policy to be effective in the short run? (10 marks)

b) Explain in words what the three-equation New Consensus model states. In particular, what causes inflation, what causes the output gap, and what is the purpose of monetary policy? (15 marks)

c) What criticisms can be made of the New Consensus model? (10 marks)

Question 4

a) Explain how quantitative easing is implemented. Use balance sheet T-accounts to illustrate your answer. Why was QE widely put into operation following the financial crisis? (10 marks)

b) Explain how QE was supposed to work, paying particular attention to the portfolio re-balancing transmission mechanism. Again, use balance sheet T-accounts to illustrate your answer. In retrospect, is the consensus view that QE did work in this way or do some people hold a different view? (20 marks)

c) What might be some of the consequences of quantitative tightening? (5 marks)

Question 5

a) How does investment drive the business cycle in Minsky’s analysis? What factors induce firms to increase their investment? (10 marks)

b) Why do firms find it easier to invest during the upswing? Answer this question by giving examples of how a credit cycle adds to business cycle dynamics on the upswing. (10 marks)

c) With credit readily available, what happens, according to Minsky, to the financial structure of firms, and why is this important? (15 marks)

Question 6

a) What problems can international capital flows cause? Make sure to distinguish across different types of flows in your discussion. (10 marks)

b) Discuss two macroeconomic policy alternatives to capital controls that can be used to deal with unwanted capital flows. (10 marks)

c) Under what circumstances might the use of capital controls be an appropriate response to a surge of capital inflows? Make sure to consider alternatives to capital controls in your discussion. (15 marks)

Question 7

a) What is the “shadow banking” system? Discuss its components and growth over time. (10 marks)

b) Explain how repo markets might contribute to financial instability and give an example of a historical episode where this occurred. Make sure to explain how your example illustrates the case. (15 marks)

c) Describe the “market maker of last resort” function for a central bank and explain how this relates to the growth of shadow banking activities. (10 marks)