The Basics: How Central Banks
Originated and Their Role Today
• The central bank started out as the
government’s bank and over the years added
various other functions.
• A modern central bank not only manages the
government’s finances but provides an array of
services to commercial banks.
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What Do Central Banks Do?
• The central bank can control the availability of
money and credit in a country's economy.
• Most central banks go about this by adjusting
short-term interest rates: monetary policy.
• They use it to stabilize economic growth and
information.
• Central banks generally do not control fiscal policy.
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How Do Central Banks Control
Interest Rates?
Conventional Monetary
Policy:
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Interest Rates
• There are three interest rates, at least in the
United States, though many countries have
comparable rates:
• The federal funds rate,
• The discount rate, and
• The deposit rate.
• These are the primary tools of monetary policy
during normal times.
• In a financial crisis, central banks may also
adjust the size and composition of their balance
sheet.
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Unconventional Monetary Policy
• Open Market Operations
• Quantitative Easing: Central bank purchases
securities from commercial banks, giving banks
more ability to lend
• Risk of inflation, but possible risk of additional
economic problems without unconventional
measures
• A matter of balance
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The Central Bank’s Balance Sheet:
Summary
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