The Central Bank in the world today is a key part in the role of an economy to operate efficiently and effectively. Central banks began operating in the United States in 1914. The Central Bank is commonly referred to as “The Fed.,” which performs various functions that have developed over the years. These functions play a huge importance in the operation of our economy.
The Central Bank
The central bank is a financial institution that organizes the government’s finances, controls money and credit of the economy and assists as the bank to commercial banks. The roles of the central banks are to create money and develop Monetary Policies. Monetary Policy can be used to give assistance in the way an economy is currently operating in. Monetary Policy has two effects, expansionary policy and restricted policy. Expansionary policy helps lower interest rates and raise inflation in the economy; this policy improves growth for short run for the overall performance of the economy. On the other hand, restricted policy does the exact opposite of expansionary. Restricted reduces growth and inflation in the economy. Another role of the central banks is to manage the payments system by the inter-bank payments. This role of the central banks provides loans during times an economy is not operating at its financial capacity. Lastly, the central bank oversees the commercial banks, where the central banks ensures that the financial system provides citizens confidence in their soundness. The objectives of the central banks are to provide low, stable inflation, high economic growth, stable financial markets, interest rate stability and exchange rate stability.
Objectives of the Central Banks
Inflation in an economy is much more desirable when it is low and stable. When there is a high inflation in an economy the usefulness and worthiness of the money’s value and unit of account is decreased. Therefore, low and stable inflation rates help predict better long term planning, such as, mortgages and retirement. Low and stable inflation reduces volatility, which means less risk and less compensation. Although low and stable inflation is much more desirable compared to high and unstable inflation, how low should low be? The answer to this question is the zero inflation is too low. If inflation hits zero there is risk of deflation. Deflation has effects on the economy which resulting in making debts more difficult to repay which can lead to higher loan defaults. Another issue that may occur in an economy is hyperinflation. Hyperinflation is when there is extremely high inflation, resulting in prices to double every two-three months. Hyperinflation is caused when there is a large increase in money supply, not supported by the GDP growth. This results in an imbalance in the supply and demand for money and it causes the prices to increase as the currency loses its value.
It is an important role of the central bank to decrease undesirable effects of the economy and enhance the...