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A central bank, reserve bank, or monetary authority is the institution that manages the currency, money supply, and interest rates of a state or formal monetary union,and oversees their commercial banking system. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and also generally controls the printing/coining of the national currency, which serves as the state's legal tender. A central bank also acts as a lender of last resort to the banking sector during times of financial crisis. Most central banks also have supervisory and regulatory powers to ensure the solvency of member institutions, to prevent bank runs, and to discourage reckless or fraudulent behavior by member banks.
A currency, in the most specific sense is money in any form when in use or circulation as a medium of exchange, especially circulating banknotes and coins. A more general definition is that a currency is a system of money in common use, especially for people in a nation. Under this definition, US dollars (US$), pounds sterling (£), Australian dollars (A$), European euros (€), Russian rubles (₽) and Indian Rupees (₹) are examples of currency. These various currencies are recognized as stores of value and are traded between nations in foreign exchange markets, which determine the relative values of the different currencies. Currencies in this sense are defined by governments, and each type has limited boundaries of acceptance.
In economics, the money supply is the total value of monetary assets available in an economy at a specific time. There are several ways to define "money", but standard measures usually include currency in circulation and demand deposits.
An interest rate is the amount of interest due per period, as a proportion of the amount lent, deposited or borrowed. The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited or borrowed.
Central banks in most developed nations are institutionally independent from political interference.Still, limited control by the executive and legislative bodies exists.
A developed country, industrialized country, more developed country, or more economically developed country (MEDC), is a sovereign state that has a developed economy and advanced technological infrastructure relative to other less industrialized nations. Most commonly, the criteria for evaluating the degree of economic development are gross domestic product (GDP), gross national product (GNP), the per capita income, level of industrialization, amount of widespread infrastructure and general standard of living. Which criteria are to be used and which countries can be classified as being developed are subjects of debate.
Functions of a central bank may include:
In economics, inflation is a sustained increase in the general price level of goods and services in an economy over a period of time. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation reflects a reduction in the purchasing power per unit of money – a loss of real value in the medium of exchange and unit of account within the economy. The measure of inflation is the inflation rate, the annualized percentage change in a general price index, usually the consumer price index, over time. The opposite of inflation is deflation.
In finance, an exchange rate is the rate at which one currency will be exchanged for another. It is also regarded as the value of one country’s currency in relation to another currency. For example, an interbank exchange rate of 114 Japanese yen to the United States dollar means that ¥114 will be exchanged for each US$1 or that US$1 will be exchanged for each ¥114. In this case it is said that the price of a dollar in relation to yen is ¥114, or equivalently that the price of a yen in relation to dollars is $1/114.
A lender of last resort (LOLR) is the institution in a financial system that acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank lending market and other facilities or sources have been exhausted. It is, in effect, a government guarantee of liquidity to financial institutions. Since the beginning of the 20th century, most central banks have been providers of lender of last resort facilities, and their functions usually also include ensuring liquidity in the financial market in general. The objective is to prevent economic disruption as a result of financial panics and bank runs spreading from one bank to the next from a lack of liquidity in one. Different definitions of the lender of last resort exist in literature. A comprehensive one is that it is "the discretionary provision of liquidity to a financial institution by the central bank in reaction to an adverse shock which causes an abnormal increase in demand for liquidity which cannot be met from an alternative source".
Central banks implement a country's chosen monetary policy.
Monetary policy is the process by which the monetary authority of a country, typically the central bank or currency board, controls either the cost of very short-term borrowing or the money supply, often targeting an inflation rate or interest rate to ensure price stability and general trust in the currency.
At the most basic level, monetary policy involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency (disallowed for countries in the International Monetary Fund), currency board or a currency union. When a country has its own national currency, this involves the issue of some form of standardized currency, which is essentially a form of promissory note: a promise to exchange the note for "money" under certain circumstances. Historically, this was often a promise to exchange the money for precious metals in some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of the promise to accept that currency to pay for taxes.
A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. Three types can be distinguished: specie, bullion, and exchange.
The International Monetary Fund (IMF) is an international organization headquartered in Washington, D.C., consisting of "189 countries working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world." Formed in 1944 at the Bretton Woods Conference primarily by the ideas of Harry Dexter White and John Maynard Keynes, it came into formal existence in 1945 with 29 member countries and the goal of reconstructing the international payment system. It now plays a central role in the management of balance of payments difficulties and international financial crises. Countries contribute funds to a pool through a quota system from which countries experiencing balance of payments problems can borrow money. As of 2016, the fund had SDR477 billion.
A currency board is a monetary authority which is required to maintain a fixed exchange rate with a foreign currency. This policy objective requires the conventional objectives of a central bank to be subordinated to the exchange rate target.
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 interest-free currency notes and selling them to the public (government) in exchange for interest-bearing assets such as government bonds. When a central bank wishes to purchase more bonds than their respective national governments make available, they may purchase private bonds or assets denominated in foreign currencies.
The Bulgarian National Bank is the central bank of the Republic of Bulgaria with its headquarters in Sofia. The BNB was established on 25 January 1879.
Hong Kong, officially the Hong Kong Special Administrative Region of the People's Republic of China and commonly abbreviated as HK, is a special administrative region of China on the eastern side of the Pearl River estuary in southern China. With over 7.4 million people of various nationalities in a 1,104-square-kilometre (426 sq mi) territory, Hong Kong is the world's fourth-most densely populated region.
Latvia, officially the Republic of Latvia, is a country in the Baltic region of Northern Europe. Since its independence, Latvia has been referred to as one of the Baltic states. It is bordered by Estonia to the north, Lithuania to the south, Russia to the east, and Belarus to the southeast, and shares a maritime border with Sweden to the west. Latvia has 1,957,200 inhabitants and a territory of 64,589 km2 (24,938 sq mi). The country has a temperate seasonal climate.
The European Central Bank remits its interest income to the central banks of the member countries of the European Union. The US Federal Reserve remits all its profits to the U.S. Treasury. This income, derived from the power to issue currency, is referred to as seigniorage, and usually belongs to the national government. The state-sanctioned power to create currency is called the Right of Issuance. Throughout history there have been disagreements over this power, since whoever controls the creation of currency controls the seigniorage income. The expression "monetary policy" may also refer more narrowly to the interest-rate targets and other active measures undertaken by the monetary authority.
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 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 real-wages) as involuntary unemployment:
Inflation is defined either as the devaluation of a currency or equivalently the rise of prices relative to a currency.
Since inflation lowers real wages, Keynesians view inflation as the solution to involuntary unemployment. However, "unanticipated" inflation leads to lender losses as the real interest rate will be lower than expected. Thus, Keynesian monetary policy aims for a steady rate of inflation. A publication from the Austrian School, The Case Against the Fed , argues that the efforts of the central banks to control inflation have been counterproductive.
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.
The main monetary policy instruments available to central banks are open market operation, bank reserve requirement, interest rate policy, re-lending and re-discount (including using the term repurchase market), and credit policy (often coordinated with trade policy). While capital adequacy is important, it is defined and regulated by the Bank for International Settlements, and central banks in practice generally do not apply stricter rules.
By far the most visible and obvious power of many modern central banks is to influence market interest rates; contrary to popular belief, they rarely "set" rates to a fixed number. Although the mechanism differs from country to country, most use a similar mechanism based on a central bank's ability to create as much fiat money as required.
The mechanism to move the market towards a 'target rate' (whichever specific rate is used) is generally to lend money or borrow money in theoretically unlimited quantities, until the targeted market rate is sufficiently close to the target. Central banks may do so by lending money to and borrowing money from (taking deposits from) a limited number of qualified banks, or by purchasing and selling bonds. As an example of how this functions, the Bank of Canada sets a target overnight rate, and a band of plus or minus 0.25%. Qualified banks borrow from each other within this band, but never above or below, because the central bank will always lend to them at the top of the band, and take deposits at the bottom of the band; in principle, the capacity to borrow and lend at the extremes of the band are unlimited.Other central banks use similar mechanisms.
The target rates are generally short-term rates. The actual rate that borrowers and lenders receive on the market will depend on (perceived) credit risk, maturity and other factors. For example, a central bank might set a target rate for overnight lending of 4.5%, but rates for (equivalent risk) five-year bonds might be 5%, 4.75%, or, in cases of inverted yield curves, even below the short-term rate. Many central banks have one primary "headline" rate that is quoted as the "central bank rate". In practice, they will have other tools and rates that are used, but only one that is rigorously targeted and enforced.
"The rate at which the central bank lends money can indeed be chosen at will by the central bank; this is the rate that makes the financial headlines." – Henry C.K. Liu.Liu explains further that "the U.S. central-bank lending rate is known as the Fed funds rate. The Fed sets a target for the Fed funds rate, which its Open Market Committee tries to match by lending or borrowing in the money market ... a fiat money system set by command of the central bank. The Fed is the head of the central-bank because the U.S. dollar is the key reserve currency for international trade. The global money market is a USA dollar market. All other currencies markets revolve around the U.S. dollar market." Accordingly, the U.S. situation is not typical of central banks in general.
Typically a central bank controls certain types of short-term interest rates. These influence the stock- and bond markets as well as mortgage and other interest rates. The European Central Bank for example announces its interest rate at the meeting of its Governing Council; in the case of the U.S. Federal Reserve, the Federal Reserve Board of Governors. Both the Federal Reserve and the ECB are composed of one or more central bodies that are responsible for the main decisions about interest rates and the size and type of open market operations, and several branches to execute its policies. In the case of the Federal Reserve, they are the local Federal Reserve Banks; for the ECB they are the national central banks.
A typical central bank has several interest rates or monetary policy tools it can set to influence markets.
These rates directly affect the rates in the money market, the market for short term loans.
Some central banks (e.g. in Denmark, Sweden and the Eurozone) are currently applying negative interest rates.
Through open market operations, a central bank influences the money supply in an economy. Each time it buys securities (such as a government bond or treasury bill), it in effect creates money. The central bank exchanges money for the security, increasing the money supply while lowering the supply of the specific security. Conversely, selling of securities by the central bank reduces the money supply.
Open market operations usually take the form of:
All of these interventions can also influence the foreign exchange market and thus the exchange rate. For example, the People's Bank of China and the Bank of Japan have on occasion bought several hundred billions of U.S. Treasuries, presumably in order to stop the decline of the U.S. dollar versus the renminbi and the yen.
When faced with the zero lower bound or a liquidity trap, central banks can resort to quantitative easing (QE). Like open market operations, QE consists in the purchase of financial assets by the central bank. There are however certain differences:
In that sense, quantitative easing can be considered as an extension of open market operations.
All banks are required to hold a certain percentage of their assets as capital, a rate which may be established by the central bank or the banking supervisor. For international banks, including the 55 member central banks of the Bank for International Settlements, the threshold is 8% (see the Basel Capital Accords) of risk-adjusted assets, whereby certain assets (such as government bonds) are considered to have lower risk and are either partially or fully excluded from total assets for the purposes of calculating capital adequacy. Partly due to concerns about asset inflation and repurchase agreements, capital requirements may be considered more effective than reserve requirements in preventing indefinite lending: when at the threshold, a bank cannot extend another loan without acquiring further capital on its balance sheet.
Historically, bank reserves have formed only a small fraction of deposits, a system called fractional reserve banking. Banks would hold only a small percentage of their assets in the form of cash reserves as insurance against bank runs. Over time this process has been regulated and insured by central banks. Such legal reserve requirements were introduced in the 19th century as an attempt to reduce the risk of banks overextending themselves and suffering from bank runs, as this could lead to knock-on effects on other overextended banks. See also money multiplier.
As the early 20th century gold standard was undermined by inflation and the late 20th century fiat dollar hegemony evolved, and as banks proliferated and engaged in more complex transactions and were able to profit from dealings globally on a moment's notice, these practices became mandatory, if only to ensure that there was some limit on the ballooning of money supply. Such limits have become harder to enforce. The People's Bank of China retains (and uses) more powers over reserves because the yuan that it manages is a non-convertible currency.
Loan activity by banks plays a fundamental role in determining the money supply. The central-bank money after aggregate settlement – "final money" – can take only one of two forms:
The currency component of the money supply is far smaller than the deposit component. Currency, bank reserves and institutional loan agreements together make up the monetary base, called M1, M2 and M3. The Federal Reserve Bank stopped publishing M3 and counting it as part of the money supply in 2006.
Central banks can directly control the money supply by placing limits on the amount banks can lend to various sectors of the economy.Central banks can also control the amount of lending by applying credit quotas. This allows the central bank to control both the quantity of lending and its allocation towards certain strategic sectors of the economy, for example to support the national industrial policy. The Bank of Japan used to apply such policy ("window guidance") between 1962 and 1991.
To influence the money supply, some central banks may require that some or all foreign exchange receipts (generally from exports) be exchanged for the local currency. The rate that is used to purchase local currency may be market-based or arbitrarily set by the bank. This tool is generally used in countries with non-convertible currencies or partially convertible currencies. The recipient of the local currency may be allowed to freely dispose of the funds, required to hold the funds with the central bank for some period of time, or allowed to use the funds subject to certain restrictions. In other cases, the ability to hold or use the foreign exchange may be otherwise limited.
In this method, money supply is increased by the central bank when it purchases the foreign currency by issuing (selling) the local currency. The central bank may subsequently reduce the money supply by various means, including selling bonds or foreign exchange interventions.
In some countries, central banks may have other tools that work indirectly to limit lending practices and otherwise restrict or regulate capital markets. For example, a central bank may regulate margin lending, whereby individuals or companies may borrow against pledged securities. The margin requirement establishes a minimum ratio of the value of the securities to the amount borrowed.
Central banks often have requirements for the quality of assets that may be held by financial institutions; these requirements may act as a limit on the amount of risk and leverage created by the financial system. These requirements may be direct, such as requiring certain assets to bear certain minimum credit ratings, or indirect, by the central bank lending to counterparties only when security of a certain quality is pledged as collateral.
Although the perception by the public may be that the "central bank" controls some or all interest rates and currency rates, economic theory (and substantial empirical evidence) shows that it is impossible to do both at once in an open economy. Robert Mundell's "impossible trinity" is the most famous formulation of these limited powers, and postulates that it is impossible to target monetary policy (broadly, interest rates), the exchange rate (through a fixed rate) and maintain free capital movement. Since most Western economies are now considered "open" with free capital movement, this essentially means that central banks may target interest rates or exchange rates with credibility, but not both at once.
In the most famous case of policy failure, Black Wednesday, George Soros arbitraged the pound sterling's relationship to the ECU and (after making $2 billion himself and forcing the UK to spend over $8bn defending the pound) forced it to abandon its policy. Since then he has been a harsh critic of clumsy bank policies and argued that no one should be able to do what he did.[ citation needed ]
The most complex relationships are those between the yuan and the US dollar, and between the euro and its neighbors. US dollars were ubiquitous in Cuba's economy after its legalization in 1991, but were officially removed from circulation in 2004 and replaced by the convertible peso.
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Some have envisaged the use of what Milton Friedman once called "helicopter money" whereby the central bank would make direct transfers to citizensin order to lift inflation up to the central bank's intended target. Such policy option could be particularly effective at the zero lower bound.
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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 UK Treasury, or by an independent government agency, for example, UK's Financial Conduct Authority. It examines the banks' balance sheets and behaviour and policies toward consumers.[ clarification needed ] Apart from refinancing, it also provides banks with services such as transfer of funds, bank notes and coins or foreign currency. Thus it is often described as the "bank of banks".
Many countries will monitor and control the banking sector through several different agencies and for different purposes. the Bank regulation in the United States for example is highly fragmented with 3 federal agencies, the Federal Deposit Insurance Corporation, the Federal Reserve Board, or Office of the Comptroller of the Currency and numerous others on the state and the private level. There is usually significant cooperation between the agencies. For example, money center banks, deposit-taking institutions, and other types of financial institutions may be subject to different (and occasionally overlapping) regulation. Some types of banking regulation may be delegated to other levels of government, such as state or provincial governments.
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.
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.
Advocates of central bank independence argue that a central bank which is too susceptible to political direction or pressure may encourage economic cycles ("boom and bust"), as 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. In this context, independence is usually defined as the central bank's operational and management independence from the government.[ citation needed ]
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.Generally, independent central banks enjoy both goal and instrument independence.
In return to their independence, central bank 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 President of the U.S. and confirmed by the Senate,publishes verbatim transcripts, and balance sheets are audited by the Government Accountability Office.
In the 2000s there has been a trend towards increasing the independence of central banks as a way of improving long-term economic performance. 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.
The literature on central bank independence has defined a cumulative and complementary number of aspects:
It is argued that an independent central bank can run a more credible monetary policy, making market expectations more responsive to signals from the central bank.[ by whom? ] 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. Even the People's Bank of China has been accorded great latitude, though in China the official role of the bank remains that of a national bank rather than a central bank, underlined by the official refusal to "unpeg" the yuan or to revalue it "under pressure". The People's Bank of China's independence can thus be read more as independence from the US, which rules the financial markets, rather than from the Communist Party of China which rules the country. The fact that the Communist Party is not elected also relieves the pressure to please people, increasing its independence.[ citation needed ]
International organizations such as the World Bank, the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) strongly support central bank independence. [ citation needed ]
The use of money as a unit of account predates history. Government control of money is documented in the ancient Egyptian economy (2750–2150 BC).The Egyptians measured the value of goods with a central unit called shat. As many other currencies, the shat was linked to gold. The value of a shat in terms of goods was defined by government administrations. Other cultures in Asia Minor later materialised their currencies in the form of gold and silver coins.
In the medieval and the early modern period a network of professional banks was established in Southern and Central Europe.The institutes built a new tier in the financial economy. The monetary system was still controlled by government institutions, mainly through the coinage prerogative. Banks, however, could use book money to create deposits for their customers. Thus, they had the possibility to issue, lend and transfer money autonomously without direct governmental control.
In order to consolidate the monetary system, a network of public exchange banks was established at the beginning of the 17th century in main European trade centres. The Amsterdam Wisselbank was founded as a first institute in 1609. Further exchange banks were located in Hamburg, Venice and Nuremberg. The institutes offered a public infrastructure for cashless international payments.They aimed to increase the efficiency of international trade and to safeguard monetary stability. The exchange banks thus fulfilled comparable functions to modern central banks. The institutes even issued their own (book) currency, called Mark Banco.
In the early modern period, the Dutch were pioneering financial innovators who developed many advanced techniques and helped lay the foundations of modern financial systems.The Bank of Amsterdam (Amsterdam Wisselbank), established in the Dutch Republic in 1609, was a forerunner to modern central banks. The Wisselbank's innovations helped lay the foundations for the birth and development of the central banking system that now plays a vital role in the world's economy. Along with a number of subsidiary local banks, it performed many functions of a central banking system. The model of the Wisselbank as a state bank was adapted throughout Europe, including Sveriges Riksbank (1668) and the Bank of England (1694).
Established by Dutch-Latvian Johan Palmstruch in 1668, Sweden's central bank, the Riksbank, is often considered by many as the world's oldest central bank. However it lacked a central function before 1904 since it did not have a monopoly over issuing bank notes.
The establishment of the Bank of England, the model on which most modern central banks have been based, was devised by Charles Montagu, 1st Earl of Halifax, in 1694, following a proposal by the banker William Paterson three years earlier, which had not been acted upon. [ page needed ] The £1.2M was raised in 12 days; half of this was used to rebuild the Navy.In the Kingdom of England in the 1690s, public funds were in short supply, and the credit of William III's government was so low in London that it was impossible for it to borrow the £1,200,000 (at 8 percent) needed to finance the ongoing Nine Years' War with France. In order to induce subscription to the loan, Montagu proposed that the subscribers were to be incorporated as The Governor and Company of the Bank of England with long-term banking privileges including the issue of notes. The lenders would give the government cash (bullion) and also issue notes against the government bonds, which could be lent again. A Royal Charter was granted on 27 July through the passage of the Tonnage Act 1694. The bank was given exclusive possession of the government's balances, and was the only limited-liability corporation allowed to issue banknotes.
Although this establishment of the Bank of England marks the origin of central banking, it did not have the functions of a modern central bank, namely, to regulate the value of the national currency, to finance the government, to be the sole authorized distributor of banknotes, and to function as a 'lender of last resort' to banks suffering a liquidity crisis. These modern central banking functions evolved slowly through the 18th and 19th centuries.
Although the Bank was originally a private institution, by the end of the 18th century it was increasingly being regarded as a public authority with civic responsibility toward the upkeep of a healthy financial system. The currency crisis of 1797, caused by panicked depositors withdrawing from the Bank led to the government suspending convertibility of notes into specie payment. The bank was soon accused by the bullionists of causing the exchange rate to fall from over issuing banknotes, a charge which the Bank denied. Nevertheless, it was clear that the Bank was being treated as an organ of the state.[ citation needed ]
Henry Thornton, a merchant banker and monetary theorist has been described as the father of the modern central bank. An opponent of the real bills doctrine, he was a defender of the bullionist position and a significant figure in monetary theory. Thornton's process of monetary expansion anticipated the theories of Knut Wicksell regarding the "cumulative process which restates the Quantity Theory in a theoretically coherent form". As a response to the 1797 currency crisis, Thornton wrote in 1802 An Enquiry into the Nature and Effects of the Paper Credit of Great Britain , in which he argued that the increase in paper credit did not cause the crisis. The book also gives a detailed account of the British monetary system as well as a detailed examination of the ways in which the Bank of England should act to counteract fluctuations in the value of the pound.
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.Many consider the origins of the central bank to lie with the passage of the Bank Charter Act 1844. Under the 1844 Act, bullionism was institutionalized in Britain, creating a ratio between the gold reserves held by the Bank of England and the notes that the Bank could issue. The Act also placed strict curbs on the issuance of notes by the country banks.
The Bank accepted the role of 'lender of last resort' in the 1870s after criticism of its lacklustre response to the Overend-Gurney crisis. 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". Paul Tucker phrased the dictum in 2009 as follows:
…to avert panic, central banks should lend early and freely (ie without limit), to solvent firms, against good collateral, and at 'high rates'.
Central banks were established in many European countries during the 19th century.Napoleon created the Banque de France in 1800, in an attempt to improve the financing of his wars. On the continent of Europe, the Bank of France remain the most important central bank throughout the 19th century. A central banking role was played by a small group of powerful family banking houses, typified by the House of Rothschild, with branches in major cities across Europe, as well as the Hottinguer family in Switzerland and the Oppenheim family in Germany.
Although central banks today are generally associated with fiat money, the 19th and early 20th centuries central banks in most of Europe and Japan developed under the international gold standard. Free banking or currency boards were common at this time. Problems with collapses of banks during downturns, however, led to wider support for central banks in those nations which did not as yet possess them, most notably in Australia.
Australia established its first central bank in 1920, Peru in 1922, Colombia in 1923, Mexico and Chile in 1925 and Canada, India and New Zealand in the aftermath of the Great Depression in 1934. By 1935, the only significant independent nation that did not possess a central bank was Brazil, which subsequently developed a precursor thereto in 1945 and the present Central Bank of Brazil twenty years later. After gaining independence, 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.
The People's Bank of China evolved its role as a central bank starting in about 1979 with the introduction of market reforms, which accelerated in 1989 when the country adopted a generally capitalist approach to its export economy. Evolving further partly in response to the European Central Bank, the People's Bank of China had by 2000 become a modern central bank. The most recent bank model was introduced together with the euro, and involves coordination of the European national banks, which continue to manage their respective economies separately in all respects other than currency exchange and base interest rates.
Alexander Hamilton as Secretary of the Treasury in the 1790s strongly promoted the banking system, and over heavy opposition from Jeffersonian Republicans, set up the First Bank of the United States. Jeffersonians allowed it to lapse, but the overwhelming financial difficulties of funding the War of 1812 without a central bank changed their minds. The Second Bank of the United States (1816–1836) under Nicholas Biddle functioned as a central bank, regulating the rapidly growing banking system.The role of a central bank was ended in the Bank War of the 1830s by President Andrew Jackson when he shut down the Second Bank as being too powerful and elitist.
In 1913 the United States created the Federal Reserve System through the passing of The Federal Reserve Act.
There is no standard terminology for the name of a central bank, but many countries use the "Bank of Country" form – for example: Bank of England (which, despite its name, is in fact the central bank of the United Kingdom as a whole. The name's lack of representation of the entire United Kingdom ('Bank of Britain', for example) can be owed to the fact that its establishment occurred when the Kingdoms of England, Scotland and Ireland were separate entities (at least in name), and therefore pre-dates the merger of the Kingdoms of England and Scotland, the Kingdom of Ireland's absorption into the Union and the formation of the present day United Kingdom), Bank of Canada, Bank of Mexico, Bank of Thailand.
The word "Reserve" is also often included, such as the Reserve Bank of India, Reserve Bank of Australia, Reserve Bank of New Zealand, the South African Reserve Bank, and Federal Reserve System. Other central banks are known as monetary authorities such as the Saudi Arabian Monetary Authority, Hong Kong Monetary Authority, Monetary Authority of Singapore, Maldives Monetary Authority and Cayman Islands Monetary Authority. There is an instance where native language was used to name the central bank: in the Philippines the Filipino name Bangko Sentral ng Pilipinas is used even in English.
Some are styled "national" banks, such as the Swiss National Bank, National Bank of Poland and National Bank of Ukraine, although the term national bank is also used for private commercial banks in some countries such as National Bank of Pakistan. In other cases, central banks may incorporate the word "Central" (for example, European Central Bank, Central Bank of Ireland, Central Bank of Brazil). In some countries, particularly in formerly Communist ones, the term national bank may be used to indicate both the monetary authority and the leading banking entity, such as the Soviet Union's Gosbank (state bank). In rare cases, central banks are styled "state" banks such as the State Bank of Pakistan and State Bank of Vietnam.
Many countries have state-owned banks or other quasi-government entities that have entirely separate functions, such as financing imports and exports. In other countries, the term national bank may be used to indicate that the central bank's goals are broader than monetary stability, such as full employment, industrial development, or other goals. Some state-owned 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.
The chief executive of a central bank is usually known as the Governor, President or Chair.
After the Financial crisis of 2007–2008 central banks led change, but as of 2015 their ability to boost economic growth has stalled. Central banks debate whether they should experiment with new measures like negative interest rates or direct financing of government, "lean even more on politicians to do more". Andy Haldane from the Bank of England said "central bankers may need to accept that their good old days – of adjusting interest rates to boost employment or contain inflation – may be gone for good". The European Central Bank and The Bank of Japan whose economies are in or close to deflation, continue quantitative easing – buying securities to encourage more lending.
Collectively, central banks purchase less than 500 tonnes of gold each year, on average (out of an annual global production of 2,500–3,000 tonnes per year).In 2018, central banks collectively hold over 33,000 metric tons of the gold, about a fifth of all the gold ever mined, according to Bloomberg News.
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.
Total assets of central banks worldwide (in trillion U.S. dollars)
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.
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'''
In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0%. Inflation reduces the value of currency over time, but deflation increases it. This allows more goods and services to be bought than before with the same amount of currency. Deflation is distinct from disinflation, a slow-down in the inflation rate, i.e. when inflation declines to a lower rate but is still positive.
Monetary policy concerns the actions of a central bank or other regulatory authorities that determine the size and rate of growth of the money supply. For example, in the United States, the Federal Reserve is in charge of monetary policy, and implements it primarily by performing operations that influence short-term interest rates.
Currency substitution or dollarization is the use of a foreign currency in parallel to or instead of the domestic currency.
As money became a commodity, the money market became a component of the financial market for assets involved in short-term borrowing, lending, buying and selling with original maturities of one year or less. Trading in money markets is done over the counter and is wholesale.
The Reserve Bank of India (RBI) is India's central banking institution, which controls the issuance and supply of the Indian rupee. Until the Monetary Policy Committee was established in 2016, it also controlled monetary policy in India. It commenced its operations on 1 April 1935 in accordance with the Reserve Bank of India Act, 1934. The original share capital was divided into shares of 100 each fully paid, which were initially owned entirely by private shareholders. Following India's independence on 15 August 1947, the RBI was nationalised on 1 January 1949.
Monetary reform is any movement or theory that proposes a system of supplying money and financing the economy that is different from the current system.
Fractional-reserve banking is the common practice by commercial banks of accepting deposits, and making loans or investments, while holding reserves at least equal to a fraction of the bank's deposit liabilities. Reserves are held as currency in the bank, or as balances in the bank's accounts at the central bank. Fractional-reserve banking is the current form of banking practiced in most countries worldwide.
An open market operation (OMO) is an activity by a central bank to give liquidity in its currency to a bank or a group of banks. The central bank can either buy or sell government bonds in the open market or, in what is now mostly the preferred solution, enter into a repo or secured lending transaction with a commercial bank: the central bank gives the money as a deposit for a defined period and synchronously takes an eligible asset as collateral. A central bank uses OMO as the primary means of implementing monetary policy. The usual aim of open market operations is—aside from supplying commercial banks with liquidity and sometimes taking surplus liquidity from commercial banks—to manipulate the short-term interest rate and the supply of base money in an economy, and thus indirectly control the total money supply, in effect expanding money or contracting the money supply. This involves meeting the demand of base money at the target interest rate by buying and selling government securities, or other financial instruments. Monetary targets, such as inflation, interest rates, or exchange rates, are used to guide this implementation.
The Bank of Korea is the central bank of the Republic of Korea and issuer of South Korean won. It was established on June 12, 1950 in Seoul, South Korea.
Money creation is the process by which the money supply of a country, or of an economic or monetary region, is increased. In most modern economies, most of the money supply is in the form of bank deposits. Central banks monitor the amount of money in the economy by measuring the so-called monetary aggregates.
Bank rate, also referred to as the discount rate in American English, is the rate of interest which a central bank charges on its loans and advances to a commercial bank. The bank rate is known by a number of different terms depending on the country, and has changed over time in some countries as the mechanisms used to manage the rate have changed.
Modern Monetary Theory or Modern Money Theory (MMT) is a heterodox macroeconomic theory that describes currency as a public monopoly for a government and unemployment as the evidence that a currency monopolist is restricting the supply of the financial assets needed to pay taxes and satisfy savings desires. MMT is seen as an evolution of chartalism and is sometimes referred to as neo-chartalism.
Quantitative easing (QE), also known as large-scale asset purchases, is a monetary policy whereby a central bank buys predetermined amounts of government bonds or other financial assets in order to inject money directly into the economy. An unconventional form of monetary policy, it is usually used when inflation is very low or negative, and standard expansionary monetary policy has become ineffective. A central bank implements quantitative easing by buying specified amounts of financial assets from commercial banks and other financial institutions, thus raising the prices of those financial assets and lowering their yield, while simultaneously lowering short term interest rates which increases the money supply. This differs from the more usual policy of buying or selling short-term government bonds to keep interbank interest rates at a specified target value.
The Bank of Albania is the central bank of Albania. The Bank of Albania has considerably evolved since being established, in contour with economic, political, and social developments. The main headquarters of the bank is in Tirana. The bank also has five other branches located in Shkodër, Elbasan, Gjirokastër, Korçë, and Lushnjë.
A fixed exchange rate, sometimes called a pegged exchange rate, is a type of exchange rate regime in which a currency's value is fixed against either the value of another single currency, a basket of other currencies, or another measure of value, such as gold.
This article is about the history of monetary policy in the United States. Monetary policy is associated with interest rates and availability of credit.
Monetary policy is the monitoring and control of money supply by a central bank, such as the Federal Reserve Board in the United States of America, and the Bangko Sentral ng Pilipinas in the Philippines. This is used by the government to be able to control inflation, and stabilize currency. Monetary Policy is considered to be one of the two ways that the government can influence the economy – the other one being Fiscal Policy. Monetary Policy is generally the process by which the central bank, or government controls the supply and availability of money, the cost of money, and the rate of interest.