What is a central bank?
A central bank, which is also referred to as a reserve bank, is a national financial institution mandated to stabilize its country’s currency, maintain unemployment rates at a low, and control inflation. While the government plays a role in regulating the agency, it works independently. Some of the popular central banks in the world include the US Federal Reserve, European Central Bank (ECB), and the UK’s Bank of England (BOE).
What is the role of a central bank?
One of the key responsibilities of a central bank is to enact a monetary policy as a way of controlling the supply of money in the country. In addition to printing cash, it does so by manipulating interest rates. For instance, depending on the state of the economy, the agency may decide to lower interest rates so as to increase economic growth, increase industrial activity, and heighten consumer spending. Subsequently, the nation will be in a position to lower unemployment and accomplish its set goals.
Additionally, central banks regulate their member banks. For instance, the agency dictates the amount that the financial institutions can lend to their customers. It also determines the cash reserves that the banks should have. A central bank can also act as a bank, lending funds to the government or financial institutions.
Who owns central banks?
Most central banks are owned by the government but execute their mandate autonomously. The Bank of England (BOE) is one of the entities with such an ownership structure.
On the other hand, the Bank of Japan (BOJ) and the Central Bank of the Republic of Turkey (TCMB) is partially owned by shareholders from the private sector. However, the state is still a major shareholder.
In contrast, the South African, US, and Italian governments are not official shareholders in the nations’ reserve banks.
Why should central banks remain independent?
Central banks are tasked with the role of setting monetary policy. To do so effectively, it has to be free from the influence of the political or business class. Notably, the government’s interference in a central bank can have dire consequences.
For instance, in 2020, the Turkish Lira reached a historic low. The currency’s free fall is due to President Recep Tayyip Erdogan’s influence on the country’s central bank. The head of state has repeatedly railed against the financial institution’s move to increase interest rates. The result of this intrusion is negative real rates and the depletion of the bank’s foreign exchange reserves.
A similar scenario was observed in Zimbabwe. The nation’s former president, Robert Mugabe, ordered the central bank to print large sums of money to offset several economic shocks. Subsequently, the country’s inflation rate reached 79.6 billion percent in November 2008. The figure equated to a 98% daily inflation rate, which is the 2nd highest case of hyperinflation ever recorded.
Who regulates central banks?
Central banks need to be independent to function effectively. However, as a regulator of banks and the state, it also needs to be regulated. In most countries, the president appoints the bank’s governor. The nominated individual has to be approved by the legislature.
In an effort to remain answerable to the public, central banks often present detailed reports, minutes, and statements regarding their actions and the reasons behind their decisions.
Lawmakers also play a role in regulating central banks. For instance, in the US, the Federal Reserve Chair and its board members often appear before Congress. The bank also has to submit a monetary policy report before the house biennially.
