Role of Central banks

The Dominican Republic's economic problem was a problem of liquidity rather than solvency. The high volume of short-term CDs had created high rollover risk. Tax hikes and elimination of subsidies were unpopular with the people. The country was to default on yet another coupon payment of $20 mn on September 9, 2004. 

By July 2004, inflation was 55%. The peso had depreciated from 18 to 50 for a dollar. While fiscal deficit was 8% of GDP.

The government made efforts to get the finances under control. To fill the gap created by the bailouts, the government had issued short term CDs with high yields upto 40%. 

Solvency is an enterprise's ability to meet its long-term financial obligations. While liquidity refers to its ability in the short term. An insolvent enterprise must enter bankruptcy. While an enterprise lacking liquidity can be forced into bankruptcy even if it is solvent.

The monetary program envisaged a build up of government deposits at the central bank, as a means of limiting the money supply. To improve liquidity and develop the domestic yield curve, the Central bank planned to lengthen the maturity period of its certificates.

1) There are five functions associated with central bank: power to issue notes, banker's bank, government's bank, lender of last resort and controller of credit.

2) There are three ways to control credit:

Altering bank rate; open market ops and varying reserve requirements.

" If one conservatively assumes that more than 5% of Bank loans to Chinese firms and local governments is non-performing, this would imply $1.15 tn in loan write-offs, dwarfing the amount of the U.S. bank rescue package of $700 bn in 2008. Since Chinese banks cannot absorb such a hit on their capital, the Chinese state will have to step in to recapitalise the banking sector, either by issuing bonds or printing money. The former will reduce the creditworthiness of the Chinese states and the latter will further put pressure on the Chinese currency to depreciate.

The objectives of Monetary Policy have changed with time. Since WWII, the primary objective has been growth & development. As economy grows more money is needed to facilitate the settlement of increased transactions.