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Central Banks, Their Functions and Role

 Meet the People Who Control the World's Money

A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and prevent inflation. Most central banks are governed by a board consisting of its member banks. The country's chief elected official appoints the director. The national legislative body approves him or her. That keeps the central bank aligned with the nation's long-term policy goals. At the same time, it's free of political influence in its day-to-day operations. The Bank of England first established that model. Conspiracy theories to the contrary, that's also who owns the U.S. Federal Reserve.1 Monetary Policy Central banks affect economic growth by controlling the liquidity in the financial system. They have three monetary policy tools to achieve this goal. First, they set a reserve requirement. It's the amount of cash that member banks must have on hand each night.2 The central bank uses it to control how much banks can lend. Second, they use open market operations to buy and sell securities from member banks. It changes the amount of cash on hand without changing the reserve requirement. They used this tool during the 2008 financial crisis. Banks bought government bonds and mortgage-backed securities to stabilize the banking system. The Federal Reserve added $4 trillion to its balance sheet with quantitative easing.3 It began reducing this stockpile in October 2017. Third, they set targets on interest rates they charge their member banks. That guides rates for loans, mortgages, and bonds. Raising interest rates slows growth, preventing inflation. That's known as contractionary monetary policy. Lowering rates stimulates growth, preventing or shortening a recession. That's called expansionary monetary policy. The European Central Bank lowered rates so far that they became negative.

A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and prevent inflation.

Monetary Policy Central banks affect economic growth by controlling the liquidity in the financial system. They have three monetary policy tools to achieve this goal. First, they set a reserve requirement. It's the amount of cash that member banks must have on hand each night.2 The central bank uses it to control how much banks can lend.

Bank Regulation Central banks regulate their members.8 They require enough reserves to cover potential loan losses. They are responsible for ensuring financial stability and protecting depositors' funds. In 2010, the Dodd-Frank Wall Street Reform Act gave more regulatory authority to the Fed. It created the Consumer Financial Protection Agency. That gave regulators the power to split up large banks, so they don't become "too big to fail." It eliminates loopholes for hedge funds and mortgage brokers. The Volcker Rule prohibits banks from owning hedge funds. It bans them from using investors' money to buy risky derivatives for their own profit.

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