Central bank
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A central bank, reserve bank, national bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union.[1] In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base. Many central banks also have supervisory or regulatory powers to ensure the stability of commercial banks in their jurisdiction, to prevent bank runs, and in some cases also to enforce policies on financial consumer protection and against bank fraud, money laundering, or terrorism financing.
Central banks in most
Issues like central bank independence, central bank policies and rhetoric in central bank governors discourse or the premises of
Definition
The notion of central banks as a separate category from other banks has emerged gradually, and only fully coalesced in the 20th century. In the aftermath of
Correlatively, different scholars have held different views about the timeline of emergence of the first central banks. A widely held view in the second half of the 20th century has been that
Naming
There is no universal terminology for the name of a central bank. Early central banks were often the only or principal formal financial institution in their jurisdiction, and were consequently often named "bank of" the relevant city's or country's name, e.g. the
- "Bank of [Country]": e.g. Act of Union 1707 and Acts of Union 1800 expanded its remit to the broader United Kingdom.
- "National Bank": e.g. National Bank of Belgium (1850), Bulgarian National Bank (1879), Swiss National Bank (1907), National Bank of Poland (1945), National Bank of Ukraine (1991).
- "State Bank": e.g. State Bank of Czechoslovakia (1950). "People's Bank", also associated with Communism, is used by the People's Bank of China.
- "Reserve Bank": in the U.S. Federal Reserve (1913) and thereafter British colonies or dominions, e.g. South African Reserve Bank (1921), Reserve Bank of New Zealand (1934), Reserve Bank of India (1935), Reserve Bank of Australia (1960), Reserve Bank of Fiji (1984)
- "Central Bank": e.g. Central Bank of China (1924), Central Bank of the Republic of Turkey (1930), Central Bank of Argentina (1935), Central Bank of Ireland (1943), Central Bank of Paraguay (1952), Central Bank of Brazil (1964), European Central Bank (1998).
- "Monetary Authority", e.g. Saudi Arabian Monetary Authority (est. 1952) was renamed the Saudi Central Bankin 2020 but still uses the acronym SAMA.
In some cases, the local-language name is used in English-language practice, e.g. Sveriges Riksbank (est. 1668, current name in use since 1866), De Nederlandsche Bank (est. 1814), Deutsche Bundesbank (est. 1957), or Bangko Sentral ng Pilipinas (est. 1993).
Some commercial banks have names suggestive of central banks, even if they are not: examples are the State Bank of India and Central Bank of India, National Bank of Greece, Banco do Brasil, National Bank of Pakistan, Bank of China, Bank of Cyprus, or Bank of Ireland, as well as Deutsche Bank. Some but not all of these institutions had assumed central banking roles in the past.
The leading executive of a central bank is usually known as the Governor, President, or Chair.
History
The widespread adoption of central banking is a rather recent phenomenon. At the start of the 20th century, approximately two-thirds of sovereign states did not have a central bank. Waves of central bank adoption occurred in the interwar period and in the aftermath of World War II.[18]
In the 20th century, central banks were often created with the intent to attract foreign capital, as bankers preferred to lend to countries with a central bank on the gold standard.[18]
Background
The use of
The issuance of
From the 12th century, a network of professional banks emerged primarily in Southern Europe (including Southern France, with the Cahorsins).[21] Banks could use book money to create deposits for their customers. Thus, they had the possibility to issue, lend and transfer money autonomously without direct control from political authorities.
Early municipal central banks
The Taula de canvi de Barcelona, established in 1401, is the first example of municipal, mostly public banks which pioneered central banking on a limited scale. It was soon emulated by the Bank of Saint George in the Republic of Genoa, first established in 1407, and significantly later by the Banco del Giro in the Republic of Venice and by a network of institutions in Naples that later consolidated into Banco di Napoli. Notable municipal central banks were established in the early 17th century in leading northwestern European commercial centers, namely the Bank of Amsterdam in 1609[22] and the Hamburger Bank in 1619.[23] These institutions offered a public infrastructure for cashless international payments.[24] They aimed to increase the efficiency of international trade and to safeguard monetary stability. These municipal public banks thus fulfilled comparable functions to modern central banks.[25]
Early national central banks
The Swedish central bank, known since 1866 as Sveriges Riksbank, was founded in Stockholm in 1664 from the remains of the failed Stockholms Banco and answered to the Riksdag of the Estates, Sweden's early modern parliament.[26] One role of the Swedish central bank was lending money to the government.[27]
The establishment of the
In the early 18th century, a major experiment in national central banking failed in
National central banks since 1800
Central banks were established in many European countries during the 19th century.
The theory of central banking, even though the name was not yet widely used, evolved in the 19th century.
In the United Kingdom until the mid-nineteenth century, commercial banks were able to issue their own banknotes, and notes issued by provincial banking companies were commonly in circulation.[40] Many consider the origins of the central bank to lie with the passage of the Bank Charter Act 1844.[15] Under the 1844 Act, bullionism was institutionalized in Britain,[41] creating a ratio between the gold reserves held by the Bank of England and the notes that the bank could issue.[42] The Act also placed strict curbs on the issuance of notes by the country banks.[42] The Bank of England took over a role of lender of last resort in the 1870s after criticism of its lacklustre response to the failure of Overend, Gurney and Company. The journalist Walter Bagehot wrote on the subject in Lombard Street: A Description of the Money Market, in which he advocated for the bank to officially become a lender of last resort during a credit crunch, sometimes referred to as "Bagehot's dictum".
The 19th and early 20th centuries central banks in most of Europe and
Following
Brazil established a central bank in 1945, which was a precursor to the Central Bank of Brazil created twenty years later. After gaining independence, numerous African and Asian countries also established central banks or monetary unions. The Reserve Bank of India, which had been established during British colonial rule as a private company, was nationalized in 1949 following India's independence. By the early 21st century, most of the world's countries had a national central bank set up as a public sector institution, albeit with widely varying degrees of independence.
Colonial, extraterritorial and federal central banks
Before the near-generalized adoption of the model of national public-sector central banks, a number of economies relied on a central bank that was effectively or legally run from outside their territory. The first colonial central banks, such as the
In some cases, independent countries which did not have a strong domestic base of
Yet another pattern was set in countries where federated or otherwise sub-sovereign entities had wide policy autonomy that was echoed to varying degrees in the organization of the central bank itself. These included, for example, the Austro-Hungarian Bank from 1878 to 1918, the U.S. Federal Reserve in its first two decades, the Bank deutscher Länder between 1948 and 1957, or the National Bank of Yugoslavia between 1972 and 1993. Conversely, some countries that are politically organized as federations, such as today's Canada, Mexico, or Switzerland, rely on a unitary central bank.
Supranational central banks
In the second half of the 20th century, the dismantling of colonial systems left some groups of countries using the same currency even though they had achieved national independence. In contrast to the unraveling of
The concept of supranational central banking took a globally significant dimension with the Economic and Monetary Union of the European Union and the establishment of the European Central Bank (ECB) in 1998. In 2014, the ECB took an additional role of banking supervision as part of the newly established policy of European banking union.
Central bank mandates
Price stability
The primary role of central banks is usually to maintain price stability, as defined as a specific level of inflation. Inflation is defined either as the devaluation of a currency or equivalently the rise of prices relative to a currency. Most central banks currently have an inflation target close to 2%.
Since inflation lowers
Central banks as monetary authorities in representative states are intertwined through globalized financial markets. As a regulator of one of the most widespread currencies in the global economy, the US Federal Reserve plays an outsized role in the international monetary market. Being the main supplier and rate adjusted for US dollars, the Federal Reserve implements a set of requirements to control inflation and unemployment in the US.[46]
High employment
Frictional unemployment is the time period between jobs when a worker is searching for, or transitioning from one job to another. Unemployment beyond frictional unemployment is classified as unintended unemployment. For example, structural unemployment is a form of unintended unemployment resulting from a mismatch between demand in the labour market and the skills and locations of the workers seeking employment. Macroeconomic policy generally aims to reduce unintended unemployment.
Keynes labeled any jobs that would be created by a rise in wage-goods (i.e., a decrease in
- Men are involuntarily unemployed if, in the event of a small rise in the price of wage-goods relatively to the money-wage, both the aggregate supply of labour willing to work for the current money-wage and the aggregate demand for it at that wage would be greater than the existing volume of employment.— John Maynard Keynes, The General Theory of Employment, Interest and Money p1
Economic growth
Economic growth can be enhanced by investment in capital, such as more or better machinery. A low interest rate implies that firms can borrow money to invest in their capital stock and pay less interest for it. Lowering the interest is therefore considered to encourage economic growth and is often used to alleviate times of low economic growth. On the other hand, raising the interest rate is often used in times of high economic growth as a contra-cyclical device to keep the economy from overheating and avoid market bubbles.
Further goals of monetary policy are stability of interest rates, of the financial market, and of the foreign exchange market. Goals frequently cannot be separated from each other and often conflict. Costs must therefore be carefully weighed before policy implementation.
Climate change
In the aftermath of the Paris agreement on climate change, a debate is now underway on whether central banks should also pursue environmental goals as part of their activities. In 2017, eight central banks formed the Network for Greening the Financial System (NGFS)[47] to evaluate the way in which central banks can use their regulatory and monetary policy tools to support climate change mitigation. Today more than 70 central banks are part of the NGFS.[48]
In January 2020, the European Central Bank has announced[49] it will consider climate considerations when reviewing its monetary policy framework.
Proponents of "green monetary policy" are proposing that central banks include climate-related criteria in their collateral eligibility frameworks, when conducting asset purchases and also in their refinancing operations.[50] But critics such as Jens Weidmann are arguing it is not central banks' role to conduct climate policy.[51] China is among the most advanced central banks when it comes to green monetary policy.[52] It has given green bonds preferential status to lower their yield[53] and uses window policy to direct green lending.[54]
The implications of potential stranded assets in the economy highlights one example of the embedded transition risk to climate change with potential cascade effects throughout the financial system.[55][56][57] In response, four broad types of interventions including methodology development, investor encouragement, financial regulation and policy toolkits have been adopted by or suggested for central banks.[18]
Achieving the
Quantitative easing is a potential measure that could be applied by Central banks to achieve a low-carbon transition.[18] Although there is a historical bias toward high-carbon companies, included in Central banks portfolios due to their high credit ratings, innovative approaches to quantitative easing could invert this trend to favor low-carbon assets.[18][61][62]
Considering the potential impact of central banks on climate change, it is important to consider the mandates of central banks. The mandate of a central bank can be narrow, meaning only a few objectives are given, limiting the ability of a central bank to include climate change in its policies.[18] However, central bank mandates may not necessarily have to be modified to accommodate climate change-related activities.[18] For example, the European Central Bank has incorporated carbon-emissions into its asset purchase criteria, despite its relatively narrow mandate that focuses on price stability.[63]
Central bank operations
The functions of a central bank may include:
- Monetary policy: by setting the official interest rate and controlling the money supply;
- Financial stability: acting as a government's banker and as the bankers' bank ("lender of last resort");
- Reserve management: managing a country's gold reserves and government bonds;
- Banking supervision: regulating and supervising the banking industry, and currency exchange;
- Payments system: managing or supervising means of payments and inter-banking clearing systems;
- Coins and notes issuance;
- Other functions of central banks may include economic research, statistical collection, supervision of deposit guarantee schemes, advice to government in financial policy.
Monetary policy
Central banks implement a country's chosen monetary policy.
Currency issuance
At the most basic level, monetary policy involves establishing what form of currency the country may have, whether a
A central bank may use another country's currency either directly in a currency union, or indirectly on a currency board. In the latter case, exemplified by the Bulgarian National Bank, Hong Kong and Latvia (until 2014), the local currency is backed at a fixed rate by the central bank's holdings of a foreign currency. Similar to commercial banks, central banks hold assets (government bonds, foreign exchange, gold, and other financial assets) and incur liabilities (currency outstanding). Central banks create money by issuing banknotes and loaning them to the government in exchange for interest-bearing assets such as government bonds. When central banks decide to increase the money supply by an amount which is greater than the amount their national governments decide to borrow, the central banks may purchase private bonds or assets denominated in foreign currencies.
The
Monetary policy instruments
The primary tools available to central banks are open market operations (including repurchase agreements), reserve requirements, interest rate policy (through control of the discount rate), and control of the money supply.
A central bank affects the monetary base through
If the open market operations do not lead to the desired effects, a second tool can be used: the central bank can increase or decrease the interest rate it charges on discounts or overdrafts (loans from the central bank to commercial banks, see discount window). If the interest rate on such transactions is sufficiently low, commercial banks can borrow from the central bank to meet reserve requirements and use the additional liquidity to expand their balance sheets, increasing the credit available to the economy.
A third alternative is to change the
Unconventional monetary policy
Other forms of monetary policy, particularly used when interest rates are at or near 0% and there are concerns about deflation or deflation is occurring, are referred to as unconventional monetary policy. These include
Some have envisaged the use of what Milton Friedman once called "helicopter money" whereby the central bank would make direct transfers to citizens[65] in order to lift inflation up to the central bank's intended target. Such policy option could be particularly effective at the zero lower bound.[66]
Central Bank Digital Currencies
Since 2017, prospect of implementing
Banking supervision and other activities
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In some countries a central bank, through its subsidiaries, controls and monitors the banking sector. In other countries banking supervision is carried out by a government department such as the
Many countries will monitor and control the banking sector through several different agencies and for different purposes. The
Any cartel of banks is particularly closely watched and controlled. Most countries control bank mergers and are wary of concentration in this industry due to the danger of groupthink and runaway lending bubbles based on a single point of failure, the credit culture of the few large banks.
Central bank governance and independence
Numerous governments have opted to make central banks independent. The economic logic behind central bank independence is that when governments delegate monetary policy to an independent central bank (with an anti-inflationary purpose) and away from elected politicians, monetary policy will not reflect the interests of the politicians. When governments control monetary policy, politicians may be tempted to boost economic activity in advance of an election to the detriment of the long-term health of the economy and the country. As a consequence, financial markets may not consider future commitments to low inflation to be credible when monetary policy is in the hands of elected officials, which increases the risk of capital flight. An alternative to central bank independence is to have fixed exchange rate regimes.[73][74][75]
Governments generally have some degree of influence over even "independent" central banks; the aim of independence is primarily to prevent short-term interference. In 1951, the Deutsche Bundesbank became the first central bank to be given full independence, leading this form of central bank to be referred to as the "Bundesbank model", as opposed, for instance, to the New Zealand model, which has a goal (i.e. inflation target) set by the government.
Central bank independence is usually guaranteed by legislation and the institutional framework governing the bank's relationship with elected officials, particularly the minister of finance. Central bank legislation will enshrine specific procedures for selecting and appointing the head of the central bank. Often the minister of finance will appoint the governor in consultation with the central bank's board and its incumbent governor. In addition, the legislation will specify banks governor's term of appointment. The most independent central banks enjoy a fixed non-renewable term for the governor in order to eliminate pressure on the governor to please the government in the hope of being re-appointed for a second term.[76] Generally, independent central banks enjoy both goal and instrument independence.[77]
Despite their independence, central banks are usually accountable at some level to government officials, either to the finance ministry or to parliament. For example, the Board of Governors of the U.S. Federal Reserve are nominated by the U.S. president and confirmed by the Senate,[78] publishes verbatim transcripts, and balance sheets are audited by the Government Accountability Office.[79]
In the 1990s there was a trend towards increasing the independence of central banks as a way of improving long-term economic performance.[80] While a large volume of economic research has been done to define the relationship between central bank independence and economic performance, the results are ambiguous.[81]
The literature on central bank independence has defined a cumulative and complementary number of aspects:[82][83]
- Institutional independence: The independence of the central bank is enshrined in law and shields central banks from political interference. In general terms, institutional independence means that politicians should refrain from seeking to influence monetary policy decisions, while symmetrically central banks should also avoid influencing government politics.
- Goal independence: The central bank has the right to set its own policy goals, whether inflation targeting, control of the money supply, or maintaining a fixed exchange rate. While this type of independence is more common, many central banks prefer to announce their policy goals in partnership with the appropriate government departments. This increases the transparency of the policy-setting process and thereby increases the credibility of the goals chosen by providing assurance that they will not be changed without notice. In addition, the setting of common goals by the central bank and the government helps to avoid situations where monetary and fiscal policy are in conflict; a policy combination that is clearly sub-optimal.
- Functional & operational independence: The central bank has the independence to determine the best way of achieving its policy goals, including the types of instruments used and the timing of their use. To achieve its mandate, the central bank has the authority to run its own operations (appointing staff, setting budgets, and so on.) and to organize its internal structures without excessive involvement of the government. This is the most common form of central bank independence. The granting of independence to the Bank of England in 1997 was, in fact, the granting of operational independence; the inflation target continued to be announced in the Chancellor's annual budget speech to Parliament.
- Personal independence: The other forms of independence are not possible unless central bank heads have a high security of tenure. In practice, this means that governors should hold long mandates (at least longer than the electoral cycle) and a certain degree of legal immunity.[84] One of the most common statistical indicators used in the literature[citation needed] as a proxy for central bank independence is the "turn-over-rate" of central bank governors. If a government is in the habit of appointing and replacing the governor frequently, it clearly has the capacity to micro-manage the central bank through its choice of governors.
- Financial independence: central banks have full autonomy on their budget, and some are even prohibited from financing governments. This is meant to remove incentives from politicians to influence central banks.
- Legal independence : some central banks have their own legal personality, which allows them to ratify international agreements without the government's approval (like the ECB), and to go to court.
There is very strong consensus among economists that an independent central bank can run a more credible monetary policy, making market expectations more responsive to signals from the central bank.[85] Both the Bank of England (1997) and the European Central Bank have been made independent and follow a set of published inflation targets so that markets know what to expect.[citation needed] The fact that the Communist Party is not elected also relieves the pressure to please people, increasing its independence. Populism can reduce de facto central bank independence.[86]
International organizations such as the World Bank, the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) strongly support central bank independence. This results, in part, from a belief in the intrinsic merits of increased independence. The support for independence from the international organizations also derives partly from the connection between increased independence for the central bank and increased transparency in the policy-making process. The IMF's Financial Services Action Plan (FSAP) review self-assessment, for example, includes a number of questions about central bank independence in the transparency section. An independent central bank will score higher in the review than one that is not independent.[citation needed]
Central bank independence indices
Central bank independence indices allow a quantitative analysis of central bank independence for individual countries over time. One central bank independence index is the Garriga CBI,[87] where a higher index indicates higher central bank independence, shown below for individual countries.
Statistics
Graphs are unavailable due to technical issues. There is more info on Phabricator and on MediaWiki.org. |
Collectively, central banks purchase less than 500 tonnes of
In 2016, 75% of the world's central-bank assets were controlled by four centers in China, the United States, Japan and the eurozone. The central banks of Brazil, Switzerland, Saudi Arabia, the U.K., India and Russia, each account for an average of 2.5 percent. The remaining 107 central banks hold less than 13 percent. According to data compiled by Bloomberg News, the top 10 largest central banks owned $21.4 trillion in assets, a 10 percent increase from 2015.[91]
Rank | Central Bank Profile | Total Assets |
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1 | Federal Reserve System | $8,757,460,000,000 |
2 | Bank of Japan | $5,878,875,571,224 |
3 | People's Bank of China | $5,144,760,000,000 |
4 | Deutsche Bundesbank | $3,103,230,000,000 |
5 | Bank of France | $2,138,080,000,000 |
See also
References
- ISBN 9783319106175. Archivedfrom the original on 1 July 2023. Retrieved 3 February 2019.
Although it is difficult to define central banking, ... a functional definition is most useful. ... Capie et al. (1994) define a central bank as the government's bank, the monopoly note issuer and lender of last resort.
- ^ David Fielding, "Fiscal and Monetary Policies in Developing Countries" in The New Palgrave Dictionary of Economics (Springer, 2016), p. 405: "The current norm in OECD countries is an institutionally independent central bank ... In recent years some non-OECD countries have introduced ... a degree of central bank independence and accountability."
- ^ "Public governance of central banks: an approach from new institutional economics" (PDF). The Bulletin of the Faculty of Commerce. 89 (4). March 2007. Archived (PDF) from the original on 9 October 2022.
- ISBN 978-0415459228.
- ^ "Ownership and independence of FED". Archived from the original on 25 March 2020. Retrieved 29 September 2013.
- ^ Deutsche Bundesbank#Governance
- ISBN 978-0-691-16319-2.
- ^ Scholvinck, Johan. "Making the Case for the Integration of Social and Economic Policy". UN Division for Social Policy and Development. Archived from the original on 18 November 2007.
- ^ Inskeep, Steve (24 June 2022). "The Fed's latest interest rate hike has some congressional lawmakers worried". NPR. Archived from the original on 11 March 2023. Retrieved 11 March 2023.
- ^ "Fed's rate hikes likely to cause a recession, research says". AP NEWS. 24 February 2023. Archived from the original on 14 March 2023. Retrieved 11 March 2023.
- S2CID 252426183.
- S2CID 219366102. Archived (PDF) from the original on 17 August 2017. Retrieved 27 October 2017.(PDF) from the original on 8 August 2017. Retrieved 24 March 2018.
- Cecchetti, Stephen G. (1998). "Policy Rules and Targets: Framing the Central Banker's Problem" (PDF). FRBNY Economic Policy Review. 4 (2): 1–14. Archived
Its foundation in 1694 arose out the difficulties of the Government of the day in securing subscriptions to State loans. Its primary purpose was to raise and lend money to the State and in consideration of this service it received under its Charter and various Act of Parliament, certain privileges of issuing bank notes. The corporation commenced, with an assured life of twelve years after which the Government had the right to annul its Charter on giving one year's notice. Subsequent extensions of this period coincided generally with the grant of additional loans to the State.
Further reading
- Acocella, N., Di Bartolomeo, G., and Hughes Hallett, A. [2012], "Central banks and economic policy after the crisis: what have we learned?", ch. 5 in: Baker, H. K. and Riddick, L. A. (eds.), Survey of International Finance, Oxford University Press.[ISBN missing]
External links
- List of central bank websites at the Bank for International Settlements
- International Journal of Central Banking
- "The Federal Reserve System: Purposes and Functions" – A publication of the U.S. Federal Reserve, describing its role in the macroeconomy
- A Hundred Ways to Skin a Cat: Comparing Monetary Policy Operating Procedures in the United States, Japan and the Euro Area (PDF). Archived (PDF) from the original on 9 October 2022. (176 KB) – C E V Borio, Bank for International Settlements, Basel