Central bank

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Central Bank

A central bank, also known as a reserve bank or monetary authority, is an institution that manages a state's currency, money supply, and interest rates. Central banks also oversee the commercial banking system of their respective countries. Unlike a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state and usually also prints the national currency, which serves as the state's legal tender.

Functions[edit | edit source]

Central banks perform a wide range of functions, including managing inflation, supervising the banking sector, setting the official interest rates (used to manage both inflation and the country's exchange rate), and acting as a lender of last resort to the banking sector during times of financial crisis. The objectives of central banks vary from country to country. For example, the Federal Reserve in the United States aims to promote maximum employment, stable prices, and moderate long-term interest rates. In contrast, the European Central Bank focuses on price stability in the eurozone.

Monetary Policy[edit | edit source]

One of the primary functions of a central bank is to implement monetary policy to manage inflation, consumption, growth, and liquidity. These policies are often achieved by manipulating interest rates and controlling the money supply. Central banks can increase interest rates to cool down inflation or lower them to stimulate borrowing and investment.

Banker's Bank[edit | edit source]

Central banks act as a banker's bank by holding currency and reserves of other banks and lending money to other banks in times of need. This function is crucial in preventing bank runs and maintaining stability in the financial system.

Government's Bank[edit | edit source]

Central banks also serve as the government's bank, managing its accounts, payments, and the issuance of government debt. They can influence the government's fiscal policy by setting the interest rates on loans to the government.

Structure and Independence[edit | edit source]

The structure and degree of independence of central banks vary widely from country to country. While some central banks are part of the government, others are independent institutions. Independence is often seen as crucial for a central bank's credibility and for keeping inflation low. The argument for independence is that policymakers might pursue short-term objectives that can conflict with long-term economic stability.

History[edit | edit source]

The concept of a central bank dates back to the 17th century. The Sveriges Riksbank of Sweden, established in 1668, is often considered the world's first central bank. The Bank of England was established in 1694, followed by other central banks in Europe and around the world. The 20th century saw a significant expansion in the role and functions of central banks, partly in response to economic crises such as the Great Depression.

Global Central Banks[edit | edit source]

Some of the most influential central banks in the world include the Federal Reserve (United States), the European Central Bank (Eurozone), the Bank of Japan (Japan), and the People's Bank of China (China). Each of these plays a critical role in the global economy, influencing economic policy and financial stability worldwide.

Challenges[edit | edit source]

Central banks face numerous challenges, including managing inflation, ensuring financial stability, and responding to economic crises. The increasing globalization of the financial system and the rapid innovation in financial products have made the central bank's task more complex. Additionally, central banks must navigate the delicate balance between political pressures and the need for independence to effectively manage the economy.


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Contributors: Prab R. Tumpati, MD