Role of Central Banks

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The objectives of the the central banks are normally prescribed by law, in developed countries their key function pertains to the preservation of financial stability. Also stipulated in the respective central bank statutes, are other macroeconomic objectives of monetary policy, such as economic growth, economic or exchange rate stability.

Unlike in the past, nowadays the central banks focus on three main objectives, which have been developed over the course of history. And these include price stability, economic stability and financial stability.

They render a country’s money supply, controls subsidized-loan interest rates, and  functions as a lender of last resort to the banking sector in times of financial distress.

And may also hold supervisory powers, aimed at ensuring that banks and other financial institutions observe ethical business practices according to the relevant laws.

The central bank acts as the head of the banking system of a country and the position of the central bank balance sheet shows transactions involving the supply of commercial banks with central bank money.

The opposite position to the refinancing transactions on the asset side is formed on the liabilities, representing the liabilities to commercial banks. Commercial banks place their excess liquidity reserves with the central bank. The central bank typically serves as the final funding agency, by providing liquidity to avert a loss of confidence in credit and the banking system.

This task can, however, lead to a decline of private ownership of commercial banks as a result. Therefore, the provision of cash to meet the necessary requirements will only be at high interest rates.

The currency reserves which are contained in the central bank balance sheet item (a), are among the stock of gold and gold receivables, as well as convertible foreign exchange (convertible currencies). The convertible currencies include the loans in foreign currencies in cash, bank deposits, securities and foreign loans, less the foreign liabilities in foreign currency (net foreign debt).

In countries which use fiat money, monetary policy is sometimes employed as a shorthand variation as regards the interest rate targets. To fulfil their tasks the central bank has a number of tools at its disposal, which can impact on economic development within and outside the currency area.

The extent to which the central bank carries out its functions depends on the respective monetary system. In the supply of banks with central bank money, the monetary authority is able derive some profit. And the profits normally flow to the Treasury, and in some cases, to other relevant directions.

In developed countries, it only plays a minor role in the public finances. And in countries whose ability to raise taxes is limited, the need for reserve bank financing is higher. The objective of monetary policy is the regulation of relations between the domestic currency of the economy and the currencies of other currency areas involved.

 

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