What is a central bank and does the US have one? (2024)

What is a central bank?

A central bank is a financial institution that is given privileged control over the production and distribution of money and credit to a nation or group of countries. In modern economies, the central bank is typically responsible for formulating monetary policy and regulating its member banks.

Central banks are inherently non-market or even anti-competitive institutions. Although some have been nationalized, many central banks are not government agencies and are therefore often touted as politically independent. Although a central bank is not legally owned by the government, its privileges are established and protected by law.

The crucial characteristic of a central bank – which distinguishes it from other banks – is its characterlegal monopolystatus, which gives it the privilege of issuing banknotes and cash. Privatecommercial banksIt is only allowed to issue demand obligations, such ascontrol of deposits.

Understanding central banks

Although their responsibilities vary widely depending on the country, the tasks of central banks (and the reason for their existence) usually fall into three areas.

First, central banks control and manipulate the national money supply. Theinfluence on moodof the markets when they issue currency and set interest rates on loans and bonds. Typically, central banks raise interest rates to slow growth and prevent inflation; they lower it to stimulate growth, industrial activity and consumer spending. In this way, they manage monetary policy to manage the country's economy and achieve economic goals such asFull employment.

Secondly, they regulate the member banks viacapitalclaim,reserve requirements(which determine how much banks can lend to customers and how much cash they must keep on hand) and deposit guarantees, among other instruments. They also provide loans and services to a country's banks and government and manage the countryforeign exchange reserves.

Finally, a central bank also acts as an emergency lender to ailing commercial banks and other institutions, and sometimes even to a government. For example, by purchasing government bonds, the central bank offers a politically attractive alternative to taxation when a state needs to increase revenues.

Example: Federal Reserve

In addition to the measures mentioned above, central banks have other actions at their disposal. In the US, for example, the central bank isFederal Reserve System, also known as "Fed". ThatBoard of the Federal Reserve (FRB),the governing body of the Fed, can influence the national money supply by changing reserve requirements. When minimum requirements fall, banks can lend more money and the economy's money supply increases. In contrast, an increase in the reserve requirement reduces the money supply. The Federal Reserve was founded withFederal Reserve-wet van 1913.

When the Fed cuts spendingrabatthat the banks pay forshort-term loans, it is also increasingliquidity. Lower interest rates increase the money supply, which in turn increases economic activity. But falling interest rates could boost inflation, so the Fed must tread carefully.

And the Fed can conduct open market operations to effect changefederal funds rate.The Fed buys government bonds from securities dealers, supplies them with cash, and thus increases the money supply. The Fed sells securities to get the money into its pockets and out of the system.

A brief history of central banks

The first prototypes for modern central banks were the Bank of England and the Swedish Riksbank, which date back to the 17th century.^ecentury. The Bank of England was the first to recognize the role of the banklender of last resort. Other early central banks, notably Napoleon's Bank of France and Germany's Reichsbank, were created to finance expensive government military operations.

It was largely because Europe's central banks made it easier for federal governments to grow, wage war, and enrich special interests that many of America's founding fathers – most notably Thomas Jefferson – opposed such an entity in their new country . Despite these objections, the young country had both officialsnational bankand numerousstate-approved banksin the first decades of its existence, until a 'free banking period' was introduced between 1837 and 1863.

The National Banking Act of 1863 created a network of national banks and one U.S. bank.means of payment, with New York as the central reserve city. The US then suffered a series of banking panics in 1873, 1884, 1893 and 1893.1907. In response, the United States Congress was founded in 1913Federal Reserve Systema 12 regionalFederal Reserve Bankthroughout the country to stabilize financial activity and the banking system.The new Fed helped finance World War I and World War II through issuanceGovernment bonds.

Between 1870 and 1914, when the worldvaluta'swas linkedthe Gold standardit was much easier to maintain price stability because the amount of gold available was limited. As a result, monetary expansion could not simply result from a political decision to print more moneyinflationwas easier to control. The central bank at the time was primarily responsible for maintaining the convertibility of gold into currency; it issued banknotes based on a country's gold reserves.

With the outbreak of the First World War, the gold standard was abandoned and it became clear that governments were in times of crisisbudget deficit(because war costs money) and the need for more resources would necessitate printing more money. When governments did that, they faced inflation. After the war, many governments chose to return to the gold standard in an attempt to stabilize their economies. With this increased awareness of the importance of central bank independence from any political party or government.

In these difficult timesGreat Depressionin the 1930s and the aftermath of World War II, world governments overwhelmingly supported a return to a central bank dependent on the political decision-making process. This view arose mainly from the need to gain control over war-torn economies; furthermore, newly independent nations chose to maintain control over all aspects of their countries – a backlash against colonialism. The rise of managed economies in the Eastern Bloc was also responsible for increased government interference in the macroeconomy. Ultimately, however, central bank independence from the government came back into vogue in Western economies and has prevailed as the optimal way to achieve a liberal and stable economic regime.

Central banks and deflation

There have been concerns about this for the past quarter centurydeflationhas increased after major economic crises. Japan has provided a sobering example. After the stock and real estate bubbles burst in 1989-90NikkeiIf the index lost a third of its value within a year, deflation would be entrenched.Japan's economy, which was one of the fastest growing in the world from the 1960s to the 1980s, slowed dramatically. The 90s became known asJapan's Lost Decade.

OfGreat recessionfrom 2008-2009 led to fears of a similar period of prolonged deflation in the US and elsewhere due to the catastrophic collapse in the prices of a wide range of assets. The global financial system was also thrown into turmoil by the insolvency of several major banks and financial institutions in the United States and Europe, as illustrated byThe collective brother of Lehman Brothersi September 2008.

Access to the Federal Reserve

In response in December 2008Federal Open Market Committee (FOMC), the monetary policy arm of the Federal Reserve, has addressed two major types of unconventional monetary policy tools: (1)future political leadershipand (2) large-scale asset purchases, also known asquantitative easing (QE).

The first involved lowering the federal funds target rate to near zero and keeping it there until at least mid-2013.But it is the other tool, quantitative easing, that has made headlines and become synonymous with the FedEasy moneypolicy. QE essentially involves a central bank creating new money and using it to buy securities from national banks to pump liquidity into the economy and push down long-term interest rates.In this case, the Fed was able to buy riskier assets, including mortgage-backed securities and other non-government debt.

This impacts other interest rates across the economy, and the broad decline in interest rates boosts consumer and business loan demand. Banks can meet this increased demand for loans thanks to the funds they receive from the central bank in exchange for their securities holdings.

Other anti-deflationary measures

In January 2015European Central Bank (ECB)started its own version of QE by promising to buy at least €1.1 trillion worth of bonds at a monthly rate of €60 billion through September 2016.The ECB launched its QE program six years after the Federal Reserve did, in an attempt to support Europe's fragile recovery and stave off deflation, after its unprecedented move to cut interest rates below 0% only in late 2014 had limited effect. good luck.

While the ECB was the first major central bank to experimentnegative tenant,a number of central banks in Europe, including Sweden, Denmark and Switzerland, have pushed their interest rates below zero.

Results of anti-deflation efforts

Central banks' measures appear to be winning the battle against deflation, but it is still too early to say whether they have won the war. Meanwhile, concerted efforts to prevent deflation worldwide have had some strange consequences:

• QE could lead to a hidden currency war:QE programs have caused major currencies to fall against the US dollar across the board. As most countries have exhausted almost all their options to stimulate growth,depreciation of the currencycould be the only tool left to stimulate economic growth, which could lead to hidden developmentcurrency war.
• European bond yields have turned negative:More than a quarter of debt issued by European governments, or an estimated $1.5 trillion, currently consists of debtnegative dividends.This could be a result of the ECB's bond buying program, but it could also indicate a sharp economic slowdown in the future.
• Central banks' balance sheets are bloated:Large asset purchases by the Federal Reserve, the Bank of Japan and the ECB are pushing balance sheets to record levels. Shrinking central banks' balance sheets could have negative consequences in the long term.

In Japan and Europe, central bank purchases include more than just miscellaneous non-government bonds. These two banks were actively involved in directly purchasing shares of the companies to support the economystock market, making the BoJ the largest shareholder in a number of companies including Kikkoman,the largest soy sauce producer in the country, indirectly through large positions inexchange traded funds (ETFs).).

Modern central banking issues

Currently, the Federal Reserve, European Central Bank and other major central banks are under pressure to shrink balance sheets that have ballooned during their recessionary buying spree.

Relaxation, ortaperingThese huge positions are likely to spook the market as a flood of supply is likely to keep demand in check. In some more illiquid markets, such as the MBS market, central banks also became the largest single buyers. For example, in the US, where the Fed is no longer buying and is under pressure to sell, it is unclear whether there are enough buyers at reasonable prices to move these assets out of the Fed's hands. There are fears that prices in these markets will then collapse, causing even more panic. If mortgage bonds fall in value, the other implication is that interest rates on these assets will rise, putting upward pressure on mortgage rates in the market and putting a damper on the long and slow recovery of the housing market.

One strategy that could allay fears is for central banks to let certain bonds mature and refrain from buying new ones instead of outright selling them. But even as purchases are phased out, the resilience of markets is unclear given that central banks have been such big and consistent buyers for almost a decade.