Perspectives: what is a Central Bank?

These institutions have allowed many countries to control their inflation rates

Lee en Español: Perspectivas: ¿qué es un Banco Central?

The performance of an economy is closely related to the activities carried out by a central bank, since the decisions it makes impact economic variables that affect our daily life. Therefore it’s important to know what it is and what the tasks it performs are.

A central bank is the institution in charge of executing the monetary policy of a country. It is in charge of the control and the management of the quantity of money in a determined economy, and of the issuance of the legal currency of a nation. Also, as monetary authority, it is known as the "bank of banks", since it can act as lender of last resort in the financial system. Some of the main functions of a central bank are:

  • To have a monopoly on money issuance
  • Centralization of international reserves (assets in foreign currency)
  • Dupervision of foreign exchange operations
  • Lender of last resort
  • Promotion of the proper functioning of the financial system in general

Monetary policy is the main task of a central bank, which can be understood as the decisions made in order to influence a set of macroeconomic variables, such as interest rates or the exchange rate. This happens in order to achieve objectives and targets, such as price stability and economic growth. Through monetary policy a central bank controls the quantity of money that is issued, the level of interest rates, can influence if desired on the behavior of the exchange rate, works to avoid imbalances in the balance of payments, and supervises the general conditions of the banking and financial system.

Central banks should prevent money from generating large distortions in the economy, since under certain conditions it can generate a rampant growth in inflation. Also, their decisions must be measured under the parameters of stability and predictability. Otherwise they may cause undesirable results for the economy. It must also act to prevent adverse external or internal shocks from affecting the normal evolution of the economic system.

Finally, it is important to emphasize that for al of these functions to take place, the central bank must be independent of any external pressure, mainly from the central government, so as not to incur errors such as lack of transparency, the financing of fiscal policies which generate inflation, among others. The institutional independence of a central bank is the norm in most countries of the world, which is why problems such as inflation are phenomena that happen very little in the world today.

 

Latin American Post | Felix E. Alvarez P.

Copy edited by Laura Rocha Rueda

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