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A central bank, reserve bank, national bank, or monetary authority is an institution that manages the monetary policy of a country or monetary union.Compare: In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base. Many central banks also have supervisory or regulatory powers to ensure the stability of in their jurisdiction, to prevent , and, in some cases, to enforce policies on financial consumer protection, and against bank fraud, money laundering, or terrorism financing. Central banks play a crucial role in macroeconomic forecasting, which is essential for guiding monetary policy decisions, especially during times of economic turbulence.
Central banks in most developed nations are usually set up to be institutionally independent from political interference,David Fielding, "Fiscal and Monetary Policies in Developing Countries" in The New Palgrave Dictionary of Economics (Springer, 2016), p. 405: "The current norm in OECD countries is an institutionally independent central bank ... In recent years some non-OECD countries have introduced ... a degree of central bank independence and accountability." even though governments typically have governance rights over them, legislative bodies exercise scrutiny, and central banks frequently do show responsiveness to politics.Deutsche Bundesbank#Governance
Issues like central bank independence, central bank policies, and rhetoric in central bank governors' discourse or the premises of macroeconomic policies (Monetary policy and fiscal policy) of the state, are a focus of contention and criticism by some policymakers, researchers, and specialized business, economics, and finance media.
Correlatively, different scholars have held different views about the timeline of emergence of the first central banks. A widely held view in the second half of the 20th century has been that Stockholms Banco (est. 1657), as the original issuer of , counted as the oldest central bank, and that consequently its successor the Sveriges Riksbank was the oldest central bank in continuous operation, with the Bank of England as second-oldest and direct or indirect model for all subsequent central banks. That view has persisted in some early-21st-century publications. In more recent scholarship, however, the issuance of banknotes has often been viewed as just one of several techniques to provide central bank money, defined as financial money (in contrast to commodity money) of the highest quality. Under that definition, municipal banks of the late medieval and early modern periods, such as the Taula de canvi de Barcelona (est. 1401) or Bank of Amsterdam (est. 1609), issued central bank money and count as early central banks.
Names of individual central banks include, with references to the date when the bank acquired its current name:
In some cases, the local-language name is used in English-language practice, e.g. Sveriges Riksbank (est. 1668, current name in use since 1866), De Nederlandsche Bank (est. 1814), italic=no (est. 1957), or Bangko Sentral ng Pilipinas (est. 1993).
Some 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, National Bank of Greece, Banco do Brasil, National Bank of Pakistan, Bank of China, Bank of Cyprus, or Bank of Ireland, as well as Deutsche Bank. Some but not all of these institutions had assumed central banking roles in the past.
The leading executive of a central bank is usually known as the Governor, President, or Chairperson.
In the 20th century, central banks were often created with the intent to attract foreign capital, as bankers preferred to lend to countries with a central bank on the gold standard.
The mere issuance of paper currency or other types of financial money by a government is not the same as central banking. The difference is that government-issued financial money, as present e.g. in China during the Yuan dynasty in the form of paper currency, is typically not freely convertibility and thus of inferior quality, occasionally leading to hyperinflation.
From the 12th century, a network of professional emerged primarily in Southern Europe (including Southern France, with the Cahorsins).Collins, Christopher. The Oxford Encyclopedia of Economic History, Volume 3. Banking: Middle Ages and Early Modern Period, Oxford University Press, 2012, pp. 221–225 Banks could use book money to create deposits for their customers. Thus, they had the possibility to issue, lend and transfer money autonomously without direct control from political authorities.
The establishment of the Bank of England was devised by Charles Montagu, 1st Earl of Halifax, following a 1691 proposal by William Paterson. A royal charter was granted on through the passage of the Tonnage Act.H. Roseveare, The Financial Revolution 1660–1760 (1991, Longman), p. 34 The bank was given exclusive possession of the government's balances, and was the only limited-liability corporation allowed to issue . The early modern Bank of England, however, did not have all the functions of a today's central banks, e.g. to regulate the value of the national currency, to finance the government, to be the sole authorized distributor of banknotes, or to function as a lender of last resort to banks suffering a liquidity crisis.
In the early 18th century, a major experiment in national central banking failed in France with John Law's Banque Royale in 1720–1721. Later in the century, France had other attempts with the Caisse d'Escompte first created in 1767, and King Charles III established the Bank of Spain in 1782. The Russian Assignation Bank, established in 1769 by Catherine the Great, was an outlier from the general pattern of early national central banks in that it was directly owned by the Imperial Russian government, rather than private individual shareholders. In the nascent United States, Alexander Hamilton, as Secretary of the Treasury in the 1790s, set up the First Bank of the United States despite heavy opposition from Jeffersonian Republicans.Federal Reserve Bank of Minneapolis. "A History of Central Banking in the United States" online
The theory of central banking, even though the name was not yet widely used, evolved in the 19th century. Henry Thornton, an opponent of the real bills doctrine, 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 a currency crisis in 1797, 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.Philippe Beaugrand, Henry Thornton, un précurseur de J.M. Keynes, Paris: Presses Universitaires de France, 1981.
In the United Kingdom 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,Anna Gambles, Protection and Politics: Conservative Economic Discourse, 1815–1852 (Royal Historical Society/Boydell Press, 1999), pp. 117–18. creating a ratio between the gold reserves held by the Bank of England and the notes that the bank could issue.Mary Poovey, Genres of the Credit Economy: Mediating Value in Eighteenth- and Nineteenth-Century Britain (University of Chicago Press, 2008), p. 49. The Act also placed strict curbs on the issuance of notes by the country banks. The Bank of England took over a role of lender of last resort in the 1870s after criticism of its lacklustre response to the failure of Overend, Gurney and Company. The journalist Walter Bagehot wrote on the subject in , 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".
The 19th and early 20th centuries central banks in most of Europe and Japan developed under the international gold standard. Free banking or were common at the 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, for example in Australia. In the United States, the role of a central bank had been ended in the so-called Bank War of the 1830s by President Andrew Jackson.Bray Hammond, "Jackson's Fight with the 'Money Power. American Heritage (June 1956) 7#4: 9–11, 100–103. In 1913, the U.S. created the Federal Reserve System through the passing of The Federal Reserve Act.Miklos Sebok, "President Wilson and the International Origins of the Federal Reserve System – A Reappraisal." White House Studies 10.4 (2011): 424–447.
Following World War I, the Economic and Financial Organization (EFO) of the League of Nations, influenced by the ideas of Montagu Norman and other leading policymakers and economists of the time, took an active role to promote the independence of central banks, a key component of the economic orthodoxy the EFO fostered at the Brussels Conference (1920). The EFO thus directed the creation of the Oesterreichische Nationalbank in Austria, Hungarian National Bank, Bank of Danzig, and Bank of Greece, as well as comprehensive reforms of the Bulgarian National Bank and Bank of Estonia. Similar ideas were emulated in other newly independent European countries, e.g. for the National Bank of Czechoslovakia.
Brazil established a central bank in 1945, which was a precursor to the Central Bank of Brazil created twenty years later. After gaining independence, numerous 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. By the early 21st century, most of the world's countries had a national central bank set up as a public sector institution, albeit with widely varying degrees of independence.
In some cases, independent countries which did not have a strong domestic base of capital accumulation and were critically reliant on foreign funding found advantage in granting a central banking role to banks that were effectively or even legally foreign. A seminal case was the Imperial Ottoman Bank established in 1863 as a French-British joint venture, and a particularly egregious one was the Paris-based National Bank of Haiti (est. 1881) which captured significant financial resources from the economically struggling albeit independent nation of Haiti. Other cases include the London-based Imperial Bank of Persia, established in 1885, and the Rome-based National Bank of Albania, established in 1925. The State Bank of Morocco was established in 1907 with international shareholding and headquarters functions distributed between Paris and Tangier, a half-decade before the country lost its independence. In other cases, there have been organized currency unions such as the Belgium–Luxembourg Economic Union established in 1921, under which Luxembourg had no central bank, but that was managed by a national central bank (in that case the National Bank of Belgium) rather than a supranational one. The present-day Common Monetary Area of Southern Africa has comparable features.
Yet another pattern was set in countries where federated or otherwise sub-sovereign entities had wide policy autonomy that was echoed to varying degrees in the organization of the central bank itself. These included, for example, the Austro-Hungarian Bank from 1878 to 1918, the U.S. Federal Reserve in its first two decades, the Bank deutscher Länder between 1948 and 1957, or the National Bank of Yugoslavia between 1972 and 1993. Conversely, some countries that are politically organized as federations, such as today's Canada, Mexico, or Switzerland, rely on a unitary central bank.
The concept of supranational central banking took a globally significant dimension with the Economic and Monetary Union of the European Union and the establishment of the European Central Bank (ECB) in 1998. In 2014, the ECB took an additional role of banking supervision as part of the newly established policy of European banking union.
Since inflation lowers , 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.
Central banks as monetary authorities in representative states are intertwined through globalized financial markets. As a regulator of one of the most widespread currencies in the global economy, the US Federal Reserve plays an outsized role in the international monetary market. Being the main supplier and rate adjusted for US dollars, the Federal Reserve implements a set of requirements to control inflation and unemployment in the US.[8] , Central banks raise rates again as Fed drives global inflation fight
Keynes labeled any jobs that would be created by a rise in wage-goods (i.e., a decrease in Real wage) as involuntary unemployment:
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.
In January 2020, the European Central Bank has announced it will consider climate considerations when reviewing its monetary policy framework.
Proponents of "green monetary policy" are proposing that central banks include climate-related criteria in their collateral eligibility frameworks, when conducting asset purchases and also in their refinancing operations. But critics such as Jens Weidmann are arguing it is not central banks' role to conduct climate policy. China is among the most advanced central banks when it comes to green monetary policy. It has given green bonds preferential status to lower their yield and uses window policy to direct green lending.
The implications of potential in the economy highlights one example of the embedded transition risk to climate change with potential throughout the financial system. In response, four broad types of interventions including methodology development, investor encouragement, financial regulation and policy toolkits have been adopted by or suggested for central banks.
Achieving the 2°C threshold revolve in part around the development of climate-aligned financial regulations. A significant challenge lies in the lack of awareness among corporations and investors, driven by poor information flow and insufficient disclosure. To address this issue, regulators and central banks are promoting transparency, integrated reporting, and exposure specifications, with the goal of promoting long-term, low-carbon emission goals, rather than short-term financial objectives. These regulations aim to assess risk comprehensively, identifying carbon-intensive assets and increasing their capital requirements. This should result in high-carbon assets becoming less attractive while favoring low-carbon assets, which have historically been perceived as high-risk, and low volatility investment vehicles.
Quantitative easing is a potential measure that could be applied by Central banks to achieve a low-carbon transition. Although there is a historical bias toward high-carbon companies, included in Central banks portfolios due to their high credit ratings, innovative approaches to quantitative easing could invert this trend to favor low-carbon assets.
Considering the potential impact of central banks on climate change, it is important to consider the mandates of central banks. The mandate of a central bank can be narrow, meaning only a few objectives are given, limiting the ability of a central bank to include climate change in its policies. However, central bank mandates may not necessarily have to be modified to accommodate climate change-related activities. For example, the European Central Bank has incorporated carbon-emissions into its asset purchase criteria, despite its relatively narrow mandate that focuses on price stability.
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 and loaning them to the government in exchange for interest-bearing assets such as government bonds. When central banks decide to increase the money supply by an amount which is greater than the amount their national governments decide to borrow, the central banks may purchase private bonds or assets denominated in foreign currencies.
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 most of 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.
A central bank affects the monetary base through open market operations, if its country has a well developed market for its government bonds. This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, repurchase agreements or "repos", company bonds, or foreign currencies, in exchange for money on deposit at the central bank. Those deposits are convertible to currency, so all of these purchases or sales result in more or less base currency entering or leaving market circulation.
If the central bank wishes to decrease interest rates, it reduces its administered rates (Bank rate, the reverse repurchase agreement rate and the Discount window). This results in commercial banks bidding down the rate they pay customers on their deposits and, subsequently, loan rates are reduced commensurately. Cheaper credit can increase consumer spending or business investment, stimulating output growth. On the other hand, cheaper interest income can reduce spending, suppressing output. Additionally, when business loans are more affordable, companies can expand to keep up with consumer demand. They ultimately hire more workers, whose incomes increase, which in its turn also increases the demand. This method is usually enough to stimulate demand and drive economic growth to a higher rate. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the United States, the Federal Reserve targets the federal funds rate, the rate at which member banks lend to one another overnight; however, the monetary policy of China (since 2014) is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies.
A third alternative is to change reserve requirements. The reserve requirement refers to the proportion of total liabilities that banks must keep on hand overnight, either in its vaults or at the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. Lowering the reserve requirement frees up funds for banks to buy other profitable assets. However, even though this tool immediately increases liquidity, central banks rarely change the reserve requirement because doing so frequently adds uncertainty to banks' planning. Most modern central banks now have zero formal reserve requirement.
Some have envisaged the use of what Milton Friedman once called "helicopter money" whereby the central bank would make direct transfers to citizens in order to lift inflation up to the central bank's intended target. Such policy option could be particularly effective at the zero lower bound.
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 italic=no 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.
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.John Goodman, Monetary Sovereignty: The Politics of Central Banking in Western Europe, Cornell University Press, 1992 Generally, independent central banks enjoy both goal and instrument independence.Stanley Fischer, "Central Bank Independence"
Despite their independence, central banks 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 U.S. president and confirmed by the Senate, Who are the members of the Federal Reserve Board, and how are they selected? U.S. Federal Reserve Board of Governors FAQ, 22 July 2015 publishes verbatim transcripts, and balance sheets are audited by the Government Accountability Office. Is the Federal Reserve accountable to anyone? U.S. Federal Reserve Board of Governors FAQ 17 June 2011
In the 1990s there was 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.Banaian, Burdekin, and Willett, 1998 "Reconsidering the principal components of central bank independence: The more the merrier?"
The literature on central bank independence has defined a cumulative and complementary number of aspects:
There is very strong consensus among economists that an independent central bank can run a more credible monetary policy, making market expectations more responsive to signals from the central bank. 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. Populism can reduce de facto central bank independence.
International organizations such as the World Bank, the Bank for International Settlements (BIS) and the International Monetary Fund (IMF) strongly support central bank independence. This results, in part, from a belief in the intrinsic merits of increased independence. The support for independence from the international organizations also derives partly from the connection between increased independence for the central bank and increased transparency in the policy-making process. The IMF's Financial Services Action Plan (FSAP) review self-assessment, for example, includes a number of questions about central bank independence in the transparency section. An independent central bank will score higher in the review than one that is not independent.
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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 United Kingdom., 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. Big Central Bank Assets Jump Fastest in 5 Years to $21 Trillion Bloomberg News, 16 October 2016 Following is a ranking of the 5 biggest:
| 1 | Federal Reserve System | Washington, D.C. | 8,349.17 |
| 2 | Bank of Japan | Tokyo | 6,621.18 |
| 3 | European Central Bank | Frankfurt am Main | 6,590.00 |
| 4 | People's Bank of China | Beijing | 3,450.00 |
| 5 | Deutsche Bundesbank | Frankfurt am Main | 3,159.87 |
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