What is... | December 29, 2017

What is a central bank?

They’re banks – but not as you know them; you can’t open an account there or borrow money.

Instead of handling the day-to-day banking for individuals, central banks are public institutions that control the money supply of a country.

The central bank of the USA is the Federal Reserve, in the UK it’s the Bank of England, and in Australia it’s the Reserve Bank of Australia. European Union countries that have adopted the euro have the European Central Bank (ECB) together with their national central banks, making up the Eurosystem.

Price stability
Responsibilities of a central bank vary by country but the main job is typically to maintain price stability. In most countries, this means keeping inflation or the rise in prices of goods and services, to a target rate of around two percent a year.

Central banks mainly do this through changes to their policy rate. This is the interest rate at which a central bank lends money to commercial banks, usually in the form of short-term loans. If inflation rates are below target, the central bank will lower interest rates.

If it costs less for banks to borrow, they can offer cheaper loans and mortgages to customers, to encourage people to spend and businesses to invest. If inflation rates rise above the target, the central bank will increase interest rates to rein in the economy by making it more expensive to borrow.

The [central bank's] main job is typically to maintain price stability.

Printing money
Central banks can also stimulate the economy by purchasing assets such as bonds, in what is known as quantitative easing. This involves creating money electronically to buy these from private-sector organisations such as banks or pension funds. Pumping money into the financial system encourages financial institutions to lend more to businesses and individuals.

Central banks also usually issue the banknotes and coins in circulation within a country. And in some countries, the central bank regulates financial services firms. The Bank of England’s Prudential Regulation Authority, for example, supervises around 1,500 banks, building societies, credit unions, insurers and major investment firms. It makes sure they hold enough capital and are run in a safe and sound way.

Central banks in some countries may be owned by governments but remain free to set monetary policy without day-to-day political interference.


eZonomics team
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