A central bank, reserve bank, or monetary
authority is an institution that manages a state’s currency, money supply, and interest
rates. Central banks also usually oversee the commercial banking system of their respective
countries. In contrast to 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 usually
serves as the state’s legal tender. Central banks also act as a “lender of last resort”
to the banking sector during times of financial crisis. Most central banks usually also have
supervisory and regulatory powers to ensure the solvency of member institutions, prevent
bank runs, and prevent reckless or fraudulent behavior by member banks.
Central banks in most developed nations are institutionally designed to be independent
from political interference. Still, limited control by the executive and legislative bodies
usually exists.==History=====Early history===The use of money as a unit of account predates
history. Government control of money is documented in the ancient Egyptian economy (2750-2150
BC). The Egyptians measured the value of goods with a central unit called shat. As many other
currencies, the shat was linked to gold. The value of a shat in terms of goods was defined
by government administrations. Other cultures in Asia Minor later materialised their currencies
in the form of gold and silver coins.In the medieval and the early modern period a network
of professional banks was established in Southern and Central Europe. The institutes built a
new tier in the financial economy. The monetary system was still controlled by government
institutions, mainly through the coinage prerogative. Banks, however, could use book money to create
deposits for their customers. Thus, they had the possibility to issue, lend and transfer
money autonomously without direct governmental control.
In order to consolidate the monetary system, a network of public exchange banks was established
at the beginning of the 17th century in main European trade centres. The Amsterdam Wisselbank
was founded as a first institute in 1609. Further exchange banks were located in Hamburg,
Venice and Nuremberg. The institutes offered a public infrastructure for cashless international
payments. They aimed to increase the efficiency of international trade and to safeguard monetary
stability. The exchange banks thus fulfilled comparable functions to modern central banks.
The institutes even issued their own (book) currency, called Mark Banco.===Bank of Amsterdam (Amsterdamsche Wisselbank)
===In the early modern period, the Dutch were
pioneering financial innovators who developed many advanced techniques and helped lay the
foundations of modern financial system. The Bank of Amsterdam (Amsterdam Wisselbank),
established in the Dutch Republic in 1609, was a forerunner to modern central banks.
The Wisselbank’s innovations helped lay the foundations for the birth and development
of the central banking system that now plays a vital role in the world’s economy. Along
with a number of subsidiary local banks, it performed many functions of a central banking
system. The model of the Wisselbank as a state bank was adapted throughout Europe, including
Sveriges Riksbank (1668) and the Bank of England (1694).===Sveriges Riksbank===Established by Dutch-Latvian Johan Palmstruch
in 1668, Sveriges Riksbank (Sweden’s central bank) is often considered by many as the world’s
oldest central bank. However it lacked a central function before 1904 since it did not have
a monopoly over issuing bank notes.===Bank of England===The establishment of the Bank of England,
the model on which most modern central banks have been based, was devised by Charles Montagu,
1st Earl of Halifax, in 1694, following a proposal by the banker William Paterson three
years earlier, which had not been acted upon. In the Kingdom of England in the 1690s, public
funds were in short supply, and the credit of William III’s government was so low in
London that it was impossible for it to borrow the £1,200,000 (at 8 percent) needed to finance
the ongoing Nine Years’ War with France. In order to induce subscription to the loan,
Montagu proposed that the subscribers were to be incorporated as The Governor and Company
of the Bank of England with long-term banking privileges including the issue of notes. The
lenders would give the government cash (bullion) and also issue notes against the government
bonds, which could be lent again. A Royal Charter was granted on 27 July through the
passage of the Tonnage Act 1694. The bank was given exclusive possession of the government’s
balances, and was the only limited-liability corporation allowed to issue banknotes. The
£1.2M was raised in 12 days; half of this was used to rebuild the Navy. Although this establishment of the Bank of
England marks the origin of central banking, it did not have the functions of a modern
central bank, namely, to regulate the value of the national currency, to finance the government,
to be the sole authorized distributor of banknotes, and to function as a ‘lender of last resort’
to banks suffering a liquidity crisis. These modern central banking functions evolved slowly
through the 18th and 19th centuries.Although the Bank was originally a private institution,
by the end of the 18th century it was increasingly being regarded as a public authority with
civic responsibility toward the upkeep of a healthy financial system. The currency crisis
of 1797, caused by panicked depositors withdrawing from the Bank led to the government suspending
convertibility of notes into specie payment. The bank was soon accused by the bullionists
of causing the exchange rate to fall from over issuing banknotes, a charge which the
Bank denied. Nevertheless, it was clear that the Bank was being treated as an organ of
the state.Henry Thornton, a merchant banker and monetary theorist has been described as
the father of the modern central bank. An opponent of the real bills doctrine, he was
a defender of the bullionist position and a significant figure in monetary theory. Thornton’s
process of monetary expansion anticipated the theories of Knut Wicksell regarding the
“cumulative process which restates the Quantity Theory in a theoretically coherent form”.
As a response to the 1797 currency crisis, Thornton wrote in 1802 An Enquiry into the
Nature and Effects of the Paper Credit of Great Britain, in which he argued that the
increase in paper credit did not cause the crisis. The book also gives a detailed account
of the British monetary system as well as a detailed examination of the ways in which
the Bank of England should act to counteract fluctuations in the value of the pound. Until the mid-nineteenth century, commercial
banks were able to issue their own banknotes, and notes issued by provincial banking companies
were commonly in circulation. Many consider the origins of the central bank to lie with
the passage of the Bank Charter Act of 1844. Under this law, authorisation to issue new
banknotes was restricted to the Bank of England. At the same time, the Bank of England was
restricted to issue new banknotes only if they were 100% backed by gold or up to £14
million in government debt. The Act served to restrict the supply of new notes reaching
circulation, and gave the Bank of England an effective monopoly on the printing of new
notes.The Bank accepted the role of ‘lender of last resort’ in the 1870s after criticism
of its lacklustre response to the Overend-Gurney crisis. The journalist Walter Bagehot wrote
on the subject in Lombard Street: A Description of the Money Market, in which he advocated
for the Bank to officially become a lender of last resort during a credit crunch, sometimes
referred to as “Bagehot’s dictum”. Paul Tucker phrased the dictum in 2009 as follows: …to avert panic, central banks should lend
early and freely (ie without limit), to solvent firms, against good collateral, and at ‘high
rates’.===Spread around the world===
Central banks were established in many European countries during the 19th century. Napoleon
created the Banque de France in 1800, in an attempt to improve the financing of his wars.
On the continent of Europe, the Bank of France remain the most important central bank throughout
the 19th century. A central banking role was played by a small group of powerful family
banking houses, typified by the House of Rothschild, with branches in major cities across Europe,
as well as the Hottinguer family in Switzerland and the Oppenheim family in Germany.Although
central banks today are generally associated with fiat money, the 19th and early 20th centuries
central banks in most of Europe and Japan developed under the international gold standard.
Free banking or currency boards were common at this time. Problems with collapses of banks
during downturns, however, led to wider support for central banks in those nations which did
not as yet possess them, most notably in Australia. Australia established its first central bank
in 1920, Peru in 1922, Colombia in 1923, Mexico and Chile in 1925 and Canada, India and New
Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent
nation that did not possess a central bank was Brazil, which subsequently developed a
precursor thereto in 1945 and the present Central Bank of Brazil twenty years later.
After gaining independence, African and Asian countries also established central banks or
monetary unions. The Reserve Bank of India, which had been established during British
colonial rule as a private company, was nationalized in 1949 following India’s independence. The People’s Bank of China evolved its role
as a central bank starting in about 1979 with the introduction of market reforms, which
accelerated in 1989 when the country adopted a generally capitalist approach to its export
economy. Evolving further partly in response to the European Central Bank, the People’s
Bank of China had by 2000 become a modern central bank. The most recent bank model was
introduced together with the euro, and involves coordination of the European national banks,
which continue to manage their respective economies separately in all respects other
than currency exchange and base interest rates.===United States===Alexander Hamilton as Secretary of the Treasury
in the 1790s strongly promoted the banking system, and over heavy opposition from Jeffersonian
Republicans, set up the First Bank of the United States. Jeffersonians allowed it to
lapse, but the overwhelming financial difficulties of funding the War of 1812 without a central
bank changed their minds. The Second Bank of the United States (1816-1836) under Nicholas
Biddle functioned as a central bank, regulating the rapidly growing banking system. The role
of a central bank was ended in the Bank War of the 1830s by President Andrew Jackson when
he shut down the Second Bank as being too powerful and elitist.In 1913 the United States
created the Federal Reserve System through the passing of The Federal Reserve Act.===Naming of central banks===
There is no standard terminology for the name of a central bank, but many countries use
the “Bank of Country” form — for example: Bank of England (which, despite its name,
is in fact the central bank of the United Kingdom as a whole. The name’s lack of representation
of the entire United Kingdom (‘Bank of Britain’, for example) can be owed to the fact that
its establishment occurred when the Kingdoms of England, Scotland and Ireland were separate
entities (at least in name), and therefore pre-dates the merger of the Kingdoms of England
and Scotland, the Kingdom of Ireland’s absorption into the Union and the formation of the present
day United Kingdom), Bank of Canada, Bank of Mexico, Bank of Thailand.
The word “Reserve” is also often included, such as the Reserve Bank of India, Reserve
Bank of Australia, Reserve Bank of New Zealand, the South African Reserve Bank, and Federal
Reserve System. Other central banks are known as monetary authorities such as the Saudi
Arabian Monetary Authority, Hong Kong Monetary Authority, Monetary Authority of Singapore,
Maldives Monetary Authority and Cayman Islands Monetary Authority. There is an instance where
native language was used to name the central bank: in the Philippines the Filipino name
Bangko Sentral ng Pilipinas is used even in English.
Some are styled “national” banks, such as the Swiss National Bank, National Bank of
Poland and National Bank of Ukraine, although the term national bank is also used for private
commercial banks in some countries such as National Bank of Pakistan. In other cases,
central banks may incorporate the word “Central” (for example, European Central Bank, Central
Bank of Ireland, Central Bank of Brazil). In some countries, particularly in formerly
Communist ones, the term national bank may be used to indicate both the monetary authority
and the leading banking entity, such as the Soviet Union’s Gosbank (state bank). In rare
cases, central banks are styled “state” banks such as the State Bank of Pakistan and State
Bank of Vietnam. Many countries have state-owned banks or other
quasi-government entities that have entirely separate functions, such as financing imports
and exports. In other countries, the term national bank may be used to indicate that
the central bank’s goals are broader than monetary stability, such as full employment,
industrial development, or other goals. Some state-owned commercial banks have names suggestive
of central banks, even if they are not: examples are the Bank of India and Central Bank of
India. The chief executive of a central bank is usually
known as the Governor, President or Chair.===21st century===
After the Financial crisis of 2007–2008 central banks led change, but as of 2015 their
ability to boost economic growth has stalled. Central banks debate whether they should experiment
with new measures like negative interest rates or direct financing of government, “lean even
more on politicians to do more”. Andy Haldane from the Bank of England said “central bankers
may need to accept that their good old days – of adjusting interest rates to boost employment
or contain inflation – may be gone for good”. The European Central Bank and The Bank of
Japan whose economies are in or close to deflation, continue quantitative easing – buying securities
to encourage more lending.==Activities and responsibilities of the
central banks==Functions of a central bank may include: implementing monetary policies.
setting the official interest rate – used to manage both inflation and the country’s
exchange rate – and ensuring that this rate takes effect via a variety of policy mechanisms
controlling the nation’s entire money supply the Government’s banker and the bankers’ bank
(“lender of last resort”) managing the country’s foreign exchange and
gold reserves and the Government’s stock register regulating and supervising the banking industry==
Monetary policy==Central banks implement a country’s chosen
monetary policy.===Currency insurance===
At the most basic level, monetary policy involves establishing what form of currency the country
may have, whether a fiat currency, gold-backed currency (disallowed for countries in the
International Monetary Fund), currency board or a currency union. When a country has its
own national currency, this involves the issue of some form of standardized currency, which
is essentially a form of promissory note: a promise to exchange the note for “money”
under certain circumstances. Historically, this was often a promise to exchange the money
for precious metals in some fixed amount. Now, when many currencies are fiat money,
the “promise to pay” consists of the promise to accept that currency to pay for taxes.
A central bank may use another country’s currency either directly in a currency union, or indirectly
on a currency board. In the latter case, exemplified by the Bulgarian National Bank, Hong Kong
and Latvia, the local currency is backed at a fixed rate by the central bank’s holdings
of a foreign currency. Similar to commercial banks, central banks
hold assets (government bonds, foreign exchange, gold, and other financial assets) and incur
liabilities (currency outstanding). Central banks create money by issuing interest-free
currency notes and selling them to the public (government) in exchange for interest-bearing
assets such as government bonds. When a central bank wishes to purchase more bonds than their
respective national governments make available, they may purchase private bonds or assets
denominated in foreign currencies. The European Central Bank remits its interest
income to the central banks of the member countries of the European Union. The US Federal
Reserve remits all its profits to the U.S. Treasury. This income, derived from the power
to issue currency, is referred to as seigniorage, and usually belongs to the national government.
The state-sanctioned power to create currency is called the Right of Issuance. Throughout
history there have been disagreements over this power, since whoever controls the creation
of currency controls the seigniorage income. The expression “monetary policy” may also
refer more narrowly to the interest-rate targets and other active measures undertaken by the
monetary authority.===Goals=======High employment====
Frictional unemployment is the time period between jobs when a worker is searching for,
or transitioning from one job to another. Unemployment beyond frictional unemployment
is classified as unintended unemployment. For example, structural unemployment is a
form of unemployment resulting from a mismatch between demand in the labour market and the
skills and locations of the workers seeking employment. Macroeconomic policy generally
aims to reduce unintended unemployment. Keynes labeled any jobs that would be created
by a rise in wage-goods (i.e., a decrease in real-wages) as involuntary unemployment: Men are involuntarily unemployed if, in the
event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate
supply of labour willing to work for the current money-wage and the aggregate demand for it
at that wage would be greater than the existing volume of employment.—John Maynard Keynes,
The General Theory of Employment, Interest and Money p11====Price stability====
Inflation is defined either as the devaluation of a currency or equivalently the rise of
prices relative to a currency. Since inflation lowers real wages, Keynesians
view inflation as the solution to involuntary unemployment. However, “unanticipated” inflation
leads to lender losses as the real interest rate will be lower than expected. Thus, Keynesian
monetary policy aims for a steady rate of inflation. A publication from the Austrian
School, The Case Against the Fed, argues that the efforts of the central banks to control
inflation have been counterproductive.====Economic growth====
Economic growth can be enhanced by investment in capital, such as more or better machinery.
A low interest rate implies that firms can borrow money to invest in their capital stock
and pay less interest for it. Lowering the interest is therefore considered to encourage
economic growth and is often used to alleviate times of low economic growth. On the other
hand, raising the interest rate is often used in times of high economic growth as a contra-cyclical
device to keep the economy from overheating and avoid market bubbles. Further goals of monetary policy are stability
of interest rates, of the financial market, and of the foreign exchange market.
Goals frequently cannot be separated from each other and often conflict. Costs must
therefore be carefully weighed before policy implementation.==Policy instruments==The main monetary policy instruments available
to central banks are open market operation, bank reserve requirement, interest rate policy,
re-lending and re-discount (including using the term repurchase market), and credit policy
(often coordinated with trade policy). While capital adequacy is important, it is defined
and regulated by the Bank for International Settlements, and central banks in practice
generally do not apply stricter rules.===Interest rates===
By far the most visible and obvious power of many modern central banks is to influence
market interest rates; contrary to popular belief, they rarely “set” rates to a fixed
number. Although the mechanism differs from country to country, most use a similar mechanism
based on a central bank’s ability to create as much fiat money as required.
The mechanism to move the market towards a ‘target rate’ (whichever specific rate is
used) is generally to lend money or borrow money in theoretically unlimited quantities,
until the targeted market rate is sufficiently close to the target. Central banks may do
so by lending money to and borrowing money from (taking deposits from) a limited number
of qualified banks, or by purchasing and selling bonds. As an example of how this functions,
the Bank of Canada sets a target overnight rate, and a band of plus or minus 0.25%. Qualified
banks borrow from each other within this band, but never above or below, because the central
bank will always lend to them at the top of the band, and take deposits at the bottom
of the band; in principle, the capacity to borrow and lend at the extremes of the band
are unlimited. Other central banks use similar mechanisms.
The target rates are generally short-term rates. The actual rate that borrowers and
lenders receive on the market will depend on (perceived) credit risk, maturity and other
factors. For example, a central bank might set a target rate for overnight lending of
4.5%, but rates for (equivalent risk) five-year bonds might be 5%, 4.75%, or, in cases of
inverted yield curves, even below the short-term rate. Many central banks have one primary
“headline” rate that is quoted as the “central bank rate”. In practice, they will have other
tools and rates that are used, but only one that is rigorously targeted and enforced.
“The rate at which the central bank lends money can indeed be chosen at will by the
central bank; this is the rate that makes the financial headlines.” – Henry C.K. Liu.
Liu explains further that “the U.S. central-bank lending rate is known as the Fed funds rate.
The Fed sets a target for the Fed funds rate, which its Open Market Committee tries to match
by lending or borrowing in the money market … a fiat money system set by command of
the central bank. The Fed is the head of the central-bank because the U.S. dollar is the
key reserve currency for international trade. The global money market is a USA dollar market.
All other currencies markets revolve around the U.S. dollar market.” Accordingly, the
U.S. situation is not typical of central banks in general.
Typically a central bank controls certain types of short-term interest rates. These
influence the stock- and bond markets as well as mortgage and other interest rates. The
European Central Bank for example announces its interest rate at the meeting of its Governing
Council; in the case of the U.S. Federal Reserve, the Federal Reserve Board of Governors. Both
the Federal Reserve and the ECB are composed of one or more central bodies that are responsible
for the main decisions about interest rates and the size and type of open market operations,
and several branches to execute its policies. In the case of the Federal Reserve, they are
the local Federal Reserve Banks; for the ECB they are the national central banks.
A typical central bank has several interest rates or monetary policy tools it can set
to influence markets. Marginal lending rate – a fixed rate for
institutions to borrow money from the central bank. (In the USA this is called the discount
rate). Main refinancing rate – the publicly visible
interest rate the central bank announces. It is also known as minimum bid rate and serves
as a bidding floor for refinancing loans. (In the USA this is called the federal funds
rate). Deposit rate, generally consisting of interest
on reserves and sometimes also interest on excess reserves – the rates parties receive
for deposits at the central bank.These rates directly affect the rates in the money market,
the market for short term loans. Some central banks (eg. in Denmark, Sweden
and the Eurozone) are currently applying negative interest rates.===Open market operations===
Through open market operations, a central bank influences the money supply in an economy.
Each time it buys securities (such as a government bond or treasury bill), it in effect creates
money. The central bank exchanges money for the security, increasing the money supply
while lowering the supply of the specific security. Conversely, selling of securities
by the central bank reduces the money supply. Open market operations usually take the form
of: Buying or selling securities (“direct operations”)
to achieve an interest rate target in the interbank market .
Temporary lending of money for collateral securities (“Reverse Operations” or “repurchase
operations”, otherwise known as the “repo” market). These operations are carried out
on a regular basis, where fixed maturity loans (of one week and one month for the ECB) are
auctioned off. Foreign exchange operations such as foreign
exchange swaps.All of these interventions can also influence the foreign exchange market
and thus the exchange rate. For example, the People’s Bank of China and the Bank of Japan
have on occasion bought several hundred billions of U.S. Treasuries, presumably in order to
stop the decline of the U.S. dollar versus the renminbi and the yen.===Quantitative easing===When faced with the zero lower bound or a
liquidity trap, central banks can resort to quantitative easing (QE). Like open market
operations, QE consists in the purchase of financial assets by the central bank. There
are however certain differences: The scale of QE is much larger. The central
banks implemented QE usually announced a specific amount of assets it intends to purchase.
The duration of QE is purposefully long if not open-ended.
The asset eligibility is usually wider and more flexible under QE, allowing the central
bank to purchase bonds with longer maturity and higher risk profile.In that sense, quantitative
easing can be considered as an extension of open market operations.===Capital requirements===
All banks are required to hold a certain percentage of their assets as capital, a rate which may
be established by the central bank or the banking supervisor. For international banks,
including the 55 member central banks of the Bank for International Settlements, the threshold
is 8% (see the Basel Capital Accords) of risk-adjusted assets, whereby certain assets (such as government
bonds) are considered to have lower risk and are either partially or fully excluded from
total assets for the purposes of calculating capital adequacy. Partly due to concerns about
asset inflation and repurchase agreements, capital requirements may be considered more
effective than reserve requirements in preventing indefinite lending: when at the threshold,
a bank cannot extend another loan without acquiring further capital on its balance sheet.===Reserve requirements===
Historically, bank reserves have formed only a small fraction of deposits, a system called
fractional reserve banking. Banks would hold only a small percentage of their assets in
the form of cash reserves as insurance against bank runs. Over time this process has been
regulated and insured by central banks. Such legal reserve requirements were introduced
in the 19th century as an attempt to reduce the risk of banks overextending themselves
and suffering from bank runs, as this could lead to knock-on effects on other overextended
banks. See also money multiplier. As the early 20th century gold standard was
undermined by inflation and the late 20th century fiat dollar hegemony evolved, and
as banks proliferated and engaged in more complex transactions and were able to profit
from dealings globally on a moment’s notice, these practices became mandatory, if only
to ensure that there was some limit on the ballooning of money supply. Such limits have
become harder to enforce. The People’s Bank of China retains (and uses) more powers over
reserves because the yuan that it manages is a non-convertible currency.
Loan activity by banks plays a fundamental role in determining the money supply. The
central-bank money after aggregate settlement – “final money” – can take only one of
two forms: physical cash, which is rarely used in wholesale
financial markets, central-bank money which is rarely used by
the peopleThe currency component of the money supply is far smaller than the deposit component.
Currency, bank reserves and institutional loan agreements together make up the monetary
base, called M1, M2 and M3. The Federal Reserve Bank stopped publishing M3 and counting it
as part of the money supply in 2006.===Credit guidance and controls===
Central banks can directly control the money supply by placing limits on the amount banks
can lend to various sectors of the economy. Central banks can also control the amount
of lending by applying credit quotas. This allows the central bank to control both the
quantity of lending and its allocation towards certain strategic sectors of the economy,
for example to support the national industrial policy. The Bank of Japan used to apply such
policy (“window guidance”) between 1962 and 1991.===Exchange requirements===
To influence the money supply, some central banks may require that some or all foreign
exchange receipts (generally from exports) be exchanged for the local currency. The rate
that is used to purchase local currency may be market-based or arbitrarily set by the
bank. This tool is generally used in countries with non-convertible currencies or partially
convertible currencies. The recipient of the local currency may be allowed to freely dispose
of the funds, required to hold the funds with the central bank for some period of time,
or allowed to use the funds subject to certain restrictions. In other cases, the ability
to hold or use the foreign exchange may be otherwise limited.
In this method, money supply is increased by the central bank when it purchases the
foreign currency by issuing (selling) the local currency. The central bank may subsequently
reduce the money supply by various means, including selling bonds or foreign exchange
interventions.===Margin requirements and other tools===
In some countries, central banks may have other tools that work indirectly to limit
lending practices and otherwise restrict or regulate capital markets. For example, a central
bank may regulate margin lending, whereby individuals or companies may borrow against
pledged securities. The margin requirement establishes a minimum ratio of the value of
the securities to the amount borrowed. Central banks often have requirements for
the quality of assets that may be held by financial institutions; these requirements
may act as a limit on the amount of risk and leverage created by the financial system.
These requirements may be direct, such as requiring certain assets to bear certain minimum
credit ratings, or indirect, by the central bank lending to counterparties only when security
of a certain quality is pledged as collateral.===Limits on policy effects===
Although the perception by the public may be that the “central bank” controls some or
all interest rates and currency rates, economic theory (and substantial empirical evidence)
shows that it is impossible to do both at once in an open economy. Robert Mundell’s
“impossible trinity” is the most famous formulation of these limited powers, and postulates that
it is impossible to target monetary policy (broadly, interest rates), the exchange rate
(through a fixed rate) and maintain free capital movement. Since most Western economies are
now considered “open” with free capital movement, this essentially means that central banks
may target interest rates or exchange rates with credibility, but not both at once.
In the most famous case of policy failure, Black Wednesday, George Soros arbitraged the
pound sterling’s relationship to the ECU and (after making $2 billion himself and forcing
the UK to spend over $8bn defending the pound) forced it to abandon its policy. Since then
he has been a harsh critic of clumsy bank policies and argued that no one should be
able to do what he did.The most complex relationships are those between the yuan and the US dollar,
and between the euro and its neighbors. US dollars were ubiquitous in Cuba’s economy
after its legalization in 1991, but were officially removed from circulation in 2004 and replaced
by the convertible peso.===Forward guidance======More radical instruments===
Some have envisaged the use of what Milton Friedman once called “helicopter money” whereby
the central bank would make direct transfers to citizens in order to lift inflation up
to the central bank’s intended target. Such policy option could be particularly effective
at the zero lower bound.==Banking supervision and other activities
==In some countries a central bank, through
its subsidiaries, controls and monitors the banking sector. In other countries banking
supervision is carried out by a government department such as the UK Treasury, or by
an independent government agency, for example, UK’s Financial Conduct Authority. It examines
the banks’ balance sheets and behaviour and policies toward consumers. Apart from refinancing,
it also provides banks with services such as transfer of funds, bank notes and coins
or foreign currency. Thus it is often described as the “bank of banks”.
Many countries will monitor and control the banking sector through several different agencies
and for different purposes. the Bank regulation in the United States for example is highly
fragmented with 3 federal agencies, the Federal Deposit Insurance Corporation, the Federal
Reserve Board, or Office of the Comptroller of the Currency and numerous others on the
state and the private level. There is usually significant cooperation between the agencies.
For example, money center banks, deposit-taking institutions, and other types of financial
institutions may be subject to different (and occasionally overlapping) regulation. Some
types of banking regulation may be delegated to other levels of government, such as state
or provincial governments. Any cartel of banks is particularly closely
watched and controlled. Most countries control bank mergers and are wary of concentration
in this industry due to the danger of groupthink and runaway lending bubbles based on a single
point of failure, the credit culture of the few large banks.==Independence==
Governments generally have some degree of influence over even “independent” central
banks; the aim of independence is primarily to prevent short-term interference. The Deutsche
Bundesbank was the first central bank to be given full independence, leading this form
of central bank to be referred to as the “Bundesbank model“, as opposed, for instance, to the
New Zealand model, which has a goal (i.e. inflation target) set by the government.
Advocates of central bank independence argue that a central bank which is too susceptible
to political direction or pressure may encourage economic cycles (“boom and bust”), as politicians
may be tempted to boost economic activity in advance of an election, to the detriment
of the long-term health of the economy and the country. In this context, independence
is usually defined as the central bank’s operational and management independence from the government.Central
bank independence is usually guaranteed by legislation and the institutional framework
governing the bank’s relationship with elected officials, particularly the minister of finance.
Central bank legislation will enshrine specific procedures for selecting and appointing the
head of the central bank. Often the minister of finance will appoint the governor in consultation
with the central bank’s board and its incumbent governor. In addition, the legislation will
specify banks governor’s term of appointment. The most independent central banks enjoy a
fixed non-renewable term for the governor in order to eliminate pressure on the governor
to please the government in the hope of being re-appointed for a second term. Generally,
independent central banks enjoy both goal and instrument independence.In return to their
independence, central bank are usually accountable at some level to government officials, either
to the finance ministry or to parliament. For example, the Board of Governors of the
U.S. Federal Reserve are nominated by the President of the U.S. and confirmed by the
Senate, publishes verbatim transcripts, and balance sheets are audited by the Government
Accountability Office.In the 2000s there has been a trend towards increasing the independence
of central banks as a way of improving long-term economic performance. While a large volume
of economic research has been done to define the relationship between central bank independence
and economic performance, the results are ambiguous.The literature on central bank independence
has defined a cumulative and complementary number of aspects:
Institutional independence: The independence of the central bank is enshrined in law and
shields central bank from political interference. In general terms, institutional independence
means that politicians should refrain to seek to influence monetary policy decisions, while
symmetrically central banks should also avoid influencing government politics.
Goal independence: The central bank has the right to set its own policy goals, whether
inflation targeting, control of the money supply, or maintaining a fixed exchange rate.
While this type of independence is more common, many central banks prefer to announce their
policy goals in partnership with the appropriate government departments. This increases the
transparency of the policy setting process and thereby increases the credibility of the
goals chosen by providing assurance that they will not be changed without notice. In addition,
the setting of common goals by the central bank and the government helps to avoid situations
where monetary and fiscal policy are in conflict; a policy combination that is clearly sub-optimal.
Functional & operational independence: The central bank has the independence to determine
the best way of achieving its policy goals, including the types of instruments used and
the timing of their use. To achieve its mandate, the central bank has the authority to run
its own operations (appointing staff, setting budgets, and so on.) and to organise its internal
structures without excessive involvement of the government. This is the most common form
of central bank independence. The granting of independence to the Bank of England in
1997 was, in fact, the granting of operational independence; the inflation target continued
to be announced in the Chancellor’s annual budget speech to Parliament.
Personal independence: The other forms of independence are not possible unless central
bank heads have a high security of tenure. In practice, this means that governors should
hold long mandates (at least longer than the electoral cycle) and a certain degree of legal
immunity. One of the most common statistical indicators used in the literature as a proxy
for central bank independence is the “turn-over-rate” of central bank governors. If a government
is in the habit of appointing and replacing the governor frequently, it clearly has the
capacity to micro-manage the central bank through its choice of governors.
Financial independence: central banks have full autonomy on their budget, and some are
even prohibited from financing governments. This is meant to remove incentives from politicians
to influence central banks. Legal independence: some central banks have
their own legal personality, which allows them to ratify international agreements without
government’s approval (like the ECB) and to go in court.It is argued that an independent
central bank can run a more credible monetary policy, making market expectations more responsive
to signals from the central bank. Both the Bank of England (1997) and the European Central
Bank have been made independent and follow a set of published inflation targets so that
markets know what to expect. Even the People’s Bank of China has been accorded great latitude,
though in China the official role of the bank remains that of a national bank rather than
a central bank, underlined by the official refusal to “unpeg” the yuan or to revalue
it “under pressure”. The People’s Bank of China’s independence can thus be read more
as independence from the USA, which rules the financial markets, rather than from the
Communist Party of China which rules the country. The fact that the Communist Party is not elected
also relieves the pressure to please people, increasing its independence.International
organizations such as the World Bank, the Bank for International Settlements (BIS) and
the International Monetary Fund (IMF) strongly support central bank independence. This results,
in part, from a belief in the intrinsic merits of increased independence. The support for
independence from the international organizations also derives partly from the connection between
increased independence for the central bank and increased transparency in the policy-making
process. The IMF’s Financial Services Action Plan (FSAP) review self-assessment, for example,
includes a number of questions about central bank independence in the transparency section.
An independent central bank will score higher in the review than one that is not independent.==Statistics==
Collectively, central banks purchase less than 500 tonnes of gold each year, on average
(out of an annual global production of 2,500-3,000 tonnes per year).In 2016, 75% of the world’s
central-bank assets were controlled by four centers in China, the United States, Japan
and the eurozone. The central banks of Brazil, Switzerland, Saudi Arabia, the U.K., India
and Russia, each account for an average of 2.5 percent. The remaining 107 central banks
hold less than 13 percent. According to data compiled by Bloomberg News, the top 10 largest
central banks owned $21.4 trillion in assets, a 10 percent increase from 2015.==See also====Notes and references====Further reading==
Acocella, N. and Di Bartolomeo, G. and Hughes Hallett, A. [2012], ‘Central banks and economic
policy after the crisis: what have we learned?’, ch. 5 in: Baker, H.K. and Riddick, L.A. (eds.),
‘Survey of International Finance’, Oxford University Press.==External links==
List of central bank websites at the Bank for International Settlements
International Journal of Central Banking The Federal Reserve System: Purposes and Functions
– A publication of the U.S. Federal Reserve, describing its role in the macroeconomy
“A hundred ways to skin a cat: comparing monetary policy operating procedures in the United
States, Japan and the euro area” (PDF). (176 KB) – C E V Borio, Bank for International
Settlements, Basel