LESSON 9 - Central Banks

Main Lecture:1.Introduction A Central Bank is a financial institution that controls countrys monetary policy, and usually has several mandates including, but not limited to issuing national currency, maintaining the value of the currency, ensuring financial system stability, controlling credit supply, serving as a last-resort lender to other banks and acting as governments banker. The central bank might be or might not be independent the government. In theory independent central bank, will ensure there is no political influence over the central banks policy, however even with the so-called "independent central banks" that is not always the case. Some of the well-known central banks are the US Federal Reserve, Bank of England, Bank of Canada, Reserve Bank of Australia, and the European Central Bank. Some central banks are responsible for singles country monetary policy, for example the Bank of Canada, while others manage the monetary policy of group of countries like the European Central Bank. There is no single naming convention for central banks naming, but usually the name is in one or close to one of the following forms Bank of [Country], Central Bank of [Country] or National Bank of [Country]. One notable exception here is the US Federal Reserve. 2.Monetary Policy Central banks manage their countries monetary policies, which includes currency issuing (most world currencies are fiat currencies not backed by silver

or gold), maintaining the countrys FOREX and gold reserves, managing money supply, and managing the cost of credit by setting interest rates. The monetary policy enforced by a central bank is used in general to influence the economic activity (avoid recessions, facilitate economy growth, etc.) and control inflation. 3.Short-term Interest Rates One of the most powerful weapons in central banks arsenal is the short-term interest rate setting. The short-term interest rate is the overnight interbank lending rate. Lowering the short-term interest rate in effect lowers the cost of credit, thus stimulating people and businesses to borrow in hope to expand the economy. Increasing interest rates, makes borrowing more expensive, and is usually used to control overheating economies and inflation. 4.Open Market Operations Open market operations are purchases and/or sales of government securities in the open market. Central banks use open market operations to effectively control the money supply the total amount of money circulating in the countrys economy. Purchasing government securities expands the money supply, while selling them actually contracts the money supply.

4. Differences Between a Central Bank and a Commercial Bank

Central Bank
The central bank occupies a dominating position as it is the apex bank among all the banks in the country. There can be only one central bank for the entire economy.

Commercial Bank
A commercial bank occupies a subordinate position in the banking structure of a country.

There is a large number or network of different commercial banks in a country.

It is a non-profit making financial institution. The central bank has the monopoly power to issue currency notes from Rs.2 and above. It is owned by the central government.

It is a profit oriented financial institution. A commercial bank cannot print currency notes. The central bank has the monopoly power to issue currency notes from Rs.2 and above. It cannot act as a clearing house. Individuals and institutions are the account holders of these banks. It can provide short term and medium term loans to the individuals and industries. Only a few commercial banks are nationalized.

It can act as clearing house. All commercial banks and the government are the account holders of this bank. It can provide loans to schedule banks and financial institutions. A central bank itself is a government bank.

For Further Reading:Read Chapter 15 of the Book ' Economics by Brian Titley'