what is the central bank

What Is the Central Bank of the US?

8 min read

The central bank is the headquarters of a country’s banking system. Not only is it the headquarters, but it also has some pretty important roles. You’re in the right place if you’re curious about what they are! Today, we will unravel the many roles the Central Banks play and how they impact society.

Setting Monetary Policy

Setting monetary policy influences the supply and demand of money in an economy through changes in interest rates, reserve requirements (amounts held by banks), or other tools. It can influence inflation, employment, and economic growth.

Ensuring Financial Stability

The Central Bank also prevents crises like bank runs or asset bubbles from occurring by monitoring risks within financial markets.

What Is the Central Bank?

Central Banks Around the World

In case you didn’t know, there isn’t one central bank for everyone. Below is a list of some of the central banks around the world:

  • Europe: The Eurosystem (The European Central Bank (ECB) and the national central banks of the eurozone’s member states.
  • Spain: The Bank of Spain
  • Germany: The Deutsche Bundesbank
  • Poland: The National Bank of Poland (Narodowy Bank Polski, NBP)
  • United States: The Federal Reserve (a.k.a. the “Fed”)
  • Canada: Bank of Canada
  • Mexico: Banxio.
  • Brazil: Banco Central do Brasil.

5-Second Take Away

  • The central bank is the country’s monetary authority.
  • Usually, the central bank is a government agency, and, in many countries, it’s part of the finance ministry. 
  • It’s sometimes called a “bank regulator” because it monitors private banks and ensures they follow all the rules.
  • Stabilizes the economy by adjusting interest rates in response to economic conditions.
  • Regulates the supply of money in circulation,
  • Setsinterest rates, and
  • Makes decisions on monetary policy to ensure that financial markets are stable and operating normally. 
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The Many Roles of a Central Bank

The central bank is the country’s monetary authority. It’s responsible for the banking system, and it prints money. As expected, the Central Bank of a country plays many roles.

Keeping The Economy Stable By Adjusting Interest Rates

The Fed’s main task is stabilizing the economy by adjusting interest rates in response to economic conditions. The most important is setting interest rates (the price you pay for borrowing money). When you take out a loan from your bank, they’ll charge you an annual percentage rate (APR). 

Additionally, the Fed can change its target interest rate if inflation rises too fast or there’s unemployment. By doing so, businesses are less likely to borrow money, and consumers are less likely to spend their money on big purchases like houses or cars. 

On the other hand, if there’s too much inflation or unemployment–or both–you’ll see lower-than-normal interest rates from your bank because that makes borrowing cheaper than expected returns elsewhere (like stocks).

Setting Monetary Policy

Monetary policy is the process by which a government or central bank controls the supply of money and credit. Consequently, this impacts the level of prices in an economy. The primary tools of monetary policy are open market operations, which affect short-term interest rates, and discount window lending, which affects long-term interest rates.

Monetary policy involves managing three main instruments:

 1) reserve requirements (RR), 

2) discount rate (DR), and 

3) open market operations (OMO). 

Each instrument has its role in influencing overall financial conditions in a given country or region.

Primary Tool for Implementing Monetary Policy

The primary tool for implementing monetary policy is open market operations. In other words, transactions between a central bank and commercial banks. 

A central bank buys securities from its member banks, increasing the deposits those banks hold at their local Reserve Bank. Consequently, this gives them more cash to lend, lowering interest rates. Ultimately, this stimulates business investments and encourages consumers to borrow money for home mortgages or car purchases. 

However, the opposite effect occurs when a central bank sells securities. After all, this results in cash withdrawals from commercial banks’ accounts at their local Reserve Bank. As can be expected, this decreases lending activity and raises interest rates.

Keeping Banks Afloat

The Fed funds rate is the interest rate banks charge each other for overnight loans. Banks use these loans to meet their reserve requirements and manage cash flow, so it’s an essential benchmark for them to know the going rate.

Likewise, it’s a benchmark for other loans (like mortgages), so lenders can set their rates accordingly.

How Do Central Banks Affect Inflation?

A central bank affects inflation through monetary policy. In other words, they are increasing or decreasing the money supply in circulation.

When the central bank increases the money supply, prices rise because more currency will be in circulation, and each currency unit has less purchasing power than before.

Conversely, when a central bank decreases its holdings of government bonds (considered “safe” investments), banks have less capital available for lending. As a result, they may choose to lend less than they would have. 

History of United States Central Bank

The Federal Reserve Bank of New York was established as the country’s central bank in 1914. It is one of 12 regional banks that comprise the Federal Reserve System, which Congress created to develop monetary policy and ensure financial stability.

Like other Central Banks worldwide, The Fed is responsible for regulating banks. Moreover, this includes state-chartered banks that are members of the Federal Reserve System (known as “member banks”). It also has supervisory authority over certain financial institutions that aren’t system members, such as investment companies and mutual funds. 

The Fed’s Mandate

The Fed promotes maximum employment, stable prices, and moderate long-term interest rates. It does this by influencing monetary policy through its tools: 

  • open market operations (the buying or selling of securities),
  •  discount window lending, 
  • reserve requirements for depository institutions (banks) and,
  • term deposits offered by banks at varying maturities from overnight to one-year

In 1990, Congress gave the Board of Governors of the Federal Reserve System responsibility for supervising and regulating state banks that are members of the Federal Reserve System.

The Fed’s Board of Governors supervises all state member banks. Each regional Federal Reserve Bank supervises its own nonmember U.S.-based bank holding companies and state nonmember banks with assets greater than $1 billion. Local District Reserve Banks run smaller community banks within their districts. 

The Fed Meetings

Did you know the FOMC meets eight times yearly to decide on interest rate policy? It’s comprised of all seven members of its Board of Governors, who serve 14-year terms; five presidents from regional Federal Reserve banks; one Vice Chairman for Supervision (who also sits on the Board); and four others chosen to represent various sectors within financial services such as banking or payments systems.

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Seting Interest Rates for Loans

The Fed funds rate is the interest rate banks charge each other for overnight loans. Banks use these loans to meet their reserve requirements and manage cash flow, so it’s an essential benchmark for them to know the going rate.

It would be best not to worry about it as a consumer or business owner–you’ll never have to borrow money from another bank at this rate. Instead, it’s a benchmark for other loans (like mortgages) so lenders can set their rates accordingly.

Are the Central Banks Too Powerful?

However, much debate is now on why central banks are too powerful, creating our inflation crisis. Did you know that central bank decisions (led by the Fed) were primarily responsible for the Great Inflation of the 1970s?

With their “easy money” policies to finance massive national budget deficits, the framework was set. Sadly, this behavior continues today. The central bank has created inflation by lowering interest rates and printing too much money.

Final Thoughts: What Is the Central Bank?

The main reason why governments have central banks is to control inflation — but their role has expanded over time. Today, they also help manage economic growth and stabilize a nation’s currency by adjusting interest rates and other monetary policies. However, lots of debate exists today on the lack of accountability of Central Banks. 

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