Central bank
A central bank is a national institution responsible for managing a country's currency, regulating monetary policy, and overseeing member banks. It plays a crucial role in controlling the money supply and setting interest rates to promote financial stability, low inflation, and maximum employment. Central banks, such as the Federal Reserve in the United States and the Bank of England, serve as a lender of last resort, providing liquidity to commercial banks during times of financial distress. They implement monetary policy through mechanisms like open market operations, which involve buying or selling government securities to influence the money supply and interest rates. While expansionary policies aim to stimulate economic growth, contractionary policies are utilized to combat inflation. Many central banks also engage in inflation targeting, a strategy to maintain inflation within a specified range. As global economic conditions evolve, the responsibilities and strategies of central banks continue to adapt, reflecting their significance in maintaining overall economic health.
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Central bank
A central bank is a national institution that manages a country's currency, determines monetary policy, and regulates member banks. It implements monetary policy by controlling the money supply and setting interest rates. The central bank acts as an emergency lender for commercial banks and other institutions.
The public institution acts independently of the government and seeks to ensure a nation's financial stability. A central bank acts in the interest of price stability, low inflation, and maximum employment. As the global economy experiences ups and downs, the role of the central bank in guiding economic policy continues to evolve.
Overview
The Bank of England, created in 1694, is considered the precursor for modern central banks. The Federal Reserve of the United States, or Fed, is the most powerful central bank. The Fed was formed in 1913 through the Federal Reserve Act, which established twelve Federal Reserve Banks across the country.
The major function of a central bank is conducting monetary policy. Through this policy, the central bank manages inflation, or the increase in the price level of goods and services, by adjusting the money supply and determining interest rates.
The central bank generally regulates the amount of money in circulation through open market operations. For example, the central bank seeks to pursue full employment by spurring economic growth. To instigate growth, the institution buys government securities such as bonds or bills to increase the money supply. This gives banks more money to lend and promotes spending.
Central banks also set the interest rate that commercial banks pay for borrowing from them. When the central bank drops the interest rate, this encourages banks to borrow more. Retail banks pass on the lower interest rates to customers, which discourages saving. Increasing the money supply and lowering interest rates are tools of expansionary monetary policy. However, putting too much money into the financial system can cause inflation. To beat back inflation, the central bank reduces the money supply by selling its government securities, which limits the amount of funds a bank can lend. It also raises the interest rate, which deters retail banks from borrowing from the central bank. In turn, banks raise interest rates for consumers, which encourages saving. Decreasing the money supply and increasing interest rates are tools of contractionary monetary policy.
Many central banks have started to utilize inflation targeting, which is tailoring monetary policy to keep inflation levels within a set target. The method was first adopted by the Reserve Bank of New Zealand in 1989.
A central bank has many other duties besides monetary policy. The institution is the sole issuer of coins and banknotes for a nation. It oversees the distribution of currency in circulation. The institution is the lender of last resort. A central bank prevents the collapse of the nation's banking system by loaning to commercial banks when they are short on funds.
The world financial crisis of 2007 to 2010 saw central banks add more tools to their disposal, with a greater emphasis on preserving monetary and financial stability. In the aftermath, the Fed and the Bank of Japan joined other central banks, including the Bank of England, in adopting inflation targeting.
Bibliography
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