The central bank of a country is the top most financial institution which is responsible for following some rules and regulation along with issuing the same the country’s commercial banks to follow. Typically central bank has been defined in economics as the ‘lender of the last resort’ i.e. it makes available lending opportunities for all other banks.
The central banks responsibilities come under two broad headings.
Macroeconomics:
This is actually the working of monetary policy whereby banks manage market price levels to bring economic stability. Under the monetary policy the central bank does currency issuance, maintains the country’s forex and gold reserves, controls money in circulation as well as set the interest rate for borrowing by commercial banks. In this way, the overall economic policy of the government is followed to ensure a thriving economy such that inflation is controlled and recession is avoided.
The term ‘open market operations’ encompasses the selling and purchase of government securities to the effect of controlling money supply in the economy. Central bank makes transactions in open market by injecting liquidity into the market or absorbing funds when open market transactions are made to affect inflation. To increase money circulation and decrease interest rate, central bank chooses to buy bills, bonds, and notes issued by government itself. This may lead adversely to higher inflation. If it goes to another extreme the bank sells all the bonds and securities and reduces money supply. Finally, the shrinking money stream makes a rise in interest rates, making it unfeasible for banks to borrow.
Microeconomics:
Commercial banks actually make funds available for common people after borrowing from the central bank. The rate at which commercial banks and other financial lending institutions borrow from central bank is called the ‘discount rate’. This is a very useful tactic that increases the central bank’s authority over the economy. When interest rate is lowered people and businesses are stimulated to borrow more so that economy receives short term expansion. If there’s high inflation, interest rates are increased which makes it difficult for business to borrow and run for long and hence they ‘downsize’ or close down giving way to recession.
Economists are of the view that central banks should make fair deal by restricting banks from borrowing continually so that more money is in supply. However, this policy alone receives criticism from economists for enriching the financially elite class at the expense of general public.
Some popular banks of the world include: the Bank of Canada. Some banks like Bank of Canada manage only one country’s monetary policy while other banks regulate monetary policies across a group of banks in different countries, like the European Central Bank. Central banks may or may not come under governmental influence. Even, if central banks are independent they do get instructions from governments to alter the rules.