Central Banks
Definition: A country's main bank.
The Central Bank holds a country's banking system by providing the currency of the country, notes & coins, and serves as a lender of last resort to the Commercial Banks.
The Central Bank is incharge of a country's monetary policy. This means to maintain Price stability by controlling inflation, ensuring steady GDP growth and achieve full employment in the economy.
The Central Bank is independent from a country's government/regime and thus its operations are uninfluenced by the political climate/scene.
Examples:
Fed - the Federal Reserve, Central Bank of the United States
ECB - European Central Bank, Central Bank of the European Union
BoE - Bank of England, Great Britain's Central Bank
BoC - Bank of Canada
RBA - Reserve Bank of Australia
How a Central Bank Influences an economy
a) Macroeconomic goals - Large scale /Long term goals that include maintaining price stability & steady GDP growth.
b) Microeconomic goals- Short term goals that include serving as a lender of last resort to the Commercial Banks.
A) Macroeconomic
Macroeconomic goals such as price stability & Low inflation are achieved by Monetary policies. The Central Bank performs Open Market Operations to decide these policies.
Monetary Policies only have two main objectives, to either reduce or increase the money supply in the economy which in turn affects price stability and inflation rates.
To increase Money supply, a Central Bank, through Open Market Operations, buy government bonds, bills or other government issued notes. This buying means giving money to the banks in exchange for bonds and lower the interest rate on these bonds to make it unattractive for banks to hold bonds. Thus money supply is increased since more money is given to the banks & lending rates are low for people to borrow more. But this could lead to higher inflation.
To reduce money supply, the Central Bank will sell government bonds and raise the interest rates on these bonds thus they are more attractive to the buyers (Commercial Banks) resultantly reducing the amount of money being held by the Commercial Banks and when the rates on borrowing are raised this further reduces the money supply hence reducing inflation.
B) Microeconomic
Central Banks require that every Commercial bank in a country should keep a fraction of their deposits with the central bank. This is called the reserve ratio/deposit ratio.
This is done to control money supply and so that the central bank can serve as a lender of last resort to the commercial banks.
Reserve requirements are raised when the money supply is high and needs to be reduced and lowered when money supply is low and needs to be increased. But not all central banks require commercial banks to make this deposit.
The rate at which the commercial banks & other financial facilities can borrow short term funds from the central bank is called the discount rate. To prevent commercial banks from borrowing too much & increasing money supply, the discount rate is made to be unattractive when used repeatedly
In conclusion
The Central Bank's operations can be disrupted by activities such as war and though a Central Bank is considered independent from a country's fiscal policy the ruling regime might have other plans so with time things may change.
