A Brief Introduction to Central Banks and their Functions

A central bank or monetary authority is a monopolized and usually nationalized institution with the privilege of control over the production and distribution of Finance Brokerage Stocks money and credit. In the modern times, the central bank is usually responsible for the formulation of monetary policy and the regulation of member banks.

Central banks are inherently non-market-based or even non-competitive institutions. Many central banks, as well as the Fed, are not actually government agencies. As such, they are touted as being politically independent. On the other hand, even if a central bank is not legally owned by the government, its privileges are established and are protected by the law.

Legal Monopoly

The Forex Broker List critical feature of a central bank that distinguishes it from any other types of banks is its legal monopoly feature, which grants it the privilege to issue bank notes and cash.

Privately owned commercial banks, by comparison, are only permitted to issue demand liabilities such as checking deposits.

History of Central Banks

The first prototypes of modern central banks were the Bank of England and the Swedish Riksbank, which date back to the 17th century. The Bank of England was the first to acknowledge the role of lender of last resort. Other early central banks, particularly Napoleon’s Bank of France and Germany’s Reichsbank, were established to finance expensive government military operations.

It was primarily because European central banks made it easier for governments to grow, wage war, and enrich special interests that many of United States’ founding fathers, most remarkably Thomas Jefferson, opposed establishing such an entity in the then-new country.

In spite of the objection, the young US did have both official national banks and state-chartered banks, except for a “free-banking” period between 1873 and 1863.

The National Banking Act of 1863 created a network of national banks as well as a single US currency, with New  York as the central reserve city. The United States subsequently experienced a series of bank panics in 1873, 1884, 1893, and 1907.

 As a response, the United States established the Federal Reserve System and established 12 regional Federal Reserve System and financial activity and banking operations. The new Fed helped finance World War I and World War II by buying Treasury bonds.

Functions of Central Banks

Even though their responsibilities vary widely, depending on their country, central banks’ duties (and the justification for their existence) usually fall into three areas.

First: the central bank controls and manipulates the money supply. Under this, the central bank can do things such as issuing currency and setting interest rates on loans and bonds.

Usually, central banks raise interest rates to slow growth and avoid inflation. They lower them to spur growth, industrial activity, and consumer spending.

Second, they regulate member banks through capital requirements, reserve requirements (one that dictates the amount the banks can loan to customers and how much capital they must keep on hand) and deposit guarantees, among other tools.

Finally, a central bank also serves as an emergency lender to distressed commercial banks and other institutions, and sometimes even a government. By buying government debt obligations, for instance, the central bank can provide a politically attractive alternative to taxation when a government needs to increase revenue.