-> central bank
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- A central bank is a financial institution responsible for issuing the national currency, controlling interest rates, and regulating money supply. Central banks also act as lenders of last resort for other financial institutions in times of financial crisis. They have supervisory functions so that financial establishments function properly. In addition to these responsibilities, central banks manage the government’s stock register, gold reserve, and foreign exchange of the country. They establish the official interest rate and make sure it is effective through different policy mechanisms.
Central banks, also called reserve banks, may function within one country or a group of countries as to make sure that the money supply is stable in a particular area. Central banks can be government-controlled or owned depending on the country. Alternatively, they can be established in such a way as to prevent government interference in their functions. Some argue that central banks function more effectively if they are independent from the official fiscal policy. In this way, they are not affected by the political objectives of any government or regime. Central banks should not have commercial banking interests of any kind as well. In principle, central banks handle the selling and buying of government bonds and other financial instruments and are often called governments’ banks. At the same time, political decisions and official policies should not affect the operations of central banks. The relationship between governments and central banks naturally differs from one country to another and evolves with time. To have a stable currency, central banks should function as an authority and regulator in the monetary and banking systems.
Central banks have two basic functions – macroeconomic and microeconomic. On the macroeconomic level, they regulate inflation and prices while on the microeconomic level, they are lenders of last resort. Central banks carry open market transactions which aim at improved market liquidity or absorbing extra funds to curb inflation. The central bank may seek to reduce the interest rate or increase money in circulation by buying bills, government bonds, or other instruments.
The Federal Reserve stands for the main monetary authority of the United States. While it has been established by the Congress, the Federal Reserve is not under the authority of the federal government. The Federal Reserve Act defines the aims of the monetary policy, specifying that the Federal Open Market Committee and the Board of Governors should work toward moderate interest rates in the long term, stable prices, and better employment opportunities. When price stability is maintained, the prices of goods, materials, services and labor are not affected by inflation and allow efficient distribution of resources. Stable prices also contribute to capital formation and saving. On the other hand, the Federal Reserve recognizes that some factors may affect the economy of the country in unforeseen ways. Among them are shifts in business and consumer confidence, disruptions in the oil market, natural disasters, and agricultural losses, among others.
In general, central banks aim to ensure economic growth, high employment, price stability, financial market stability, and interest rate stability. Price stability is affected by inflation, which results in losses for lending institutions. Central banks seek to establish such monetary policy that a steady rate of inflation is maintained. Another goal of monetary policy is to reduce unintended employment which is beyond frictional unemployment. Investment in technological advances facilitates economic growth through enhanced production capabilities. In addition, central banks aim to achieve interest rate stability. Volatile exchange rates and interest increase the costs for borrowers and lenders. Unexpected changes in this direction make the formulation of policy difficult and cause damage to the economy. Foreign exchange and financial market stability are also goals of monetary policy.