Central bank

A central bank, reserve bank, or monetary authority is an institution that manages the
currency and monetary policy of a state or formal monetary union,[1] and oversees their
commercial banking system. In contrast to a commercial bank, a central bank possesses a
monopoly on increasing the monetary base in a financial crisis. Most central banks also have
supervisory and regulatory powers to ensure the stability of member institutions, to prevent bank
runs, and to discourage reckless or fraudulent behavior by member banks.

Central banks in most developed nations are institutionally independent from political
interference.[2][3][4] Still, limited control by the executive and legislative bodies exists.[5][6]

Contents
Activities of central banks
Monetary policy
Currency issuance
Goals
High employment
Price stability
Economic growth
Policy instruments
Interest rates
Open market operations
Quantitative easing
Reserve requirements
Capital requirements
Credit guidance and controls
Exchange requirements
Margin requirements and other tools
Limits on policy effects
Forward guidance
More radical instruments
Banking supervision and other activities
Independence
History
Early history
Bank of Amsterdam (Amsterdamsche Wisselbank)
Sveriges Riksbank
Bank of England
Spread around the world
 United States
Naming of central banks
21st century
Statistics
Criticism
Libertarian criticisms
See also
Notes and references
Further reading
External links

Activities of central banks

Functions of a central bank may include:

setting an official interest rate – used to manage both

inflation and a country's exchange rate – and ensuring that
this rate takes effect via a variety of policy mechanisms
controlling a state's entire money supply
acting as a government's banker and as the bankers' bank
The Eccles Federal Reserve Board
("lender of last resort")
Building in Washington, D.C. houses
managing a country's foreign-exchange and gold reserves the main offices of the Board of
and government bonds Governors of the United States'
regulating and supervising the banking industry Federal Reserve System

Monetary policy
Central banks implement a country's chosen monetary policy.

Currency issuance
At the most basic level, monetary policy involves establishing what form of currency the country
may have, whether a fiat currency, gold-backed currency (disallowed for countries in the
International Monetary Fund), currency board or a currency union. When a country has its own
national currency, this involves the issue of some form of standardized currency, which is
essentially a form of promissory note: a promise to exchange the note for "money" under certain
circumstances. Historically, this was often a promise to exchange the money for precious metals in
some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of
the promise to accept that currency to pay for taxes.

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 banknotes 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.

Goals

High employment

Frictional unemployment is the time period between jobs when a worker is searching for, or
transitioning from one job to another. Unemployment beyond frictional unemployment is
classified as unintended unemployment.

For example, structural unemployment is a form of unemployment resulting from a mismatch

between demand in the labour market and the skills and locations of the workers seeking
employment. Macroeconomic policy generally aims to reduce unintended unemployment.

Keynes labeled any jobs that would be created by a rise in wage-goods (i.e., a decrease in real-
wages) as involuntary unemployment:

Men are involuntarily unemployed if, in the event of a small rise in the price of wage-
goods relatively to the money-wage, both the aggregate supply of labour willing to work
for the current money-wage and the aggregate demand for it at that wage would be
greater than the existing volume of employment.

—John Maynard Keynes, The General Theory of Employment, Interest and Money p11

Price stability

Inflation is defined either as the devaluation of a currency or equivalently the rise of prices relative
to a currency.

Since inflation lowers real wages, 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. A
publication from the Austrian School, The Case Against the Fed, argues that the efforts of the
central banks to control inflation have been counterproductive.

Economic growth
Economic growth can be enhanced by investment in capital, such as more or better machinery. A
low interest rate implies that firms can borrow money to invest in their capital stock and pay less
interest for it. Lowering the interest is therefore considered to encourage economic growth and is
often used to alleviate times of low economic growth. On the other hand, raising the interest rate is
often used in times of high economic growth as a contra-cyclical device to keep the economy from
overheating and avoid market bubbles.

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.

Policy instruments
The main monetary policy instruments available to central The European Central Bank building
banks are open market operation, bank reserve requirement, in Frankfurt
interest rate policy, re-lending and re-discount (including
using the term repurchase market), and credit policy (often
coordinated with trade policy). While capital adequacy is
important, it is defined and regulated by the Bank for
International Settlements, and central banks in practice
generally do not apply stricter rules.

Interest rates The Bank of Finland, in Helsinki,

established in 1812.
By far the most visible and obvious power of many modern
central banks is to influence market interest rates; contrary to
popular belief, they rarely "set" rates to a fixed number.
Although the mechanism differs from country to country, most
use a similar mechanism based on a central bank's ability to
create as much fiat money as required.

The mechanism to move the market towards a 'target rate'

(whichever specific rate is used) is generally to lend money or
borrow money in theoretically unlimited quantities until the
targeted market rate is sufficiently close to the target. Central
banks may do so by lending money to and borrowing money
from (taking deposits from) a limited number of qualified
banks, or by purchasing and selling bonds. As an example of
how this functions, the Bank of Canada sets a target overnight The headquarters of the Bank for
rate, and a band of plus or minus 0.25%. Qualified banks International Settlements, in Basel
(Switzerland).
borrow from each other within this band, but never above or
below, because the central bank will always lend to them at the
top of the band, and take deposits at the bottom of the band; in
principle, the capacity to borrow and lend at the extremes of the band are unlimited.[7] Other
central banks use similar mechanisms.
The target rates are generally short-term rates. The actual rate that borrowers and lenders receive
on the market will depend on (perceived) credit risk, maturity and other factors. For example, a
central bank might set a target rate for overnight lending of 4.5%, but rates for (equivalent risk)
five-year bonds might be 5%, 4.75%, or, in cases of inverted yield curves, even below the short-
term rate. Many central banks have one primary "headline" rate that is quoted as the "central bank
rate". In practice, they will have other tools and rates that are
used, but only one that is rigorously targeted and enforced.

"The rate at which the central bank lends money can indeed be
chosen at will by the central bank; this is the rate that makes
the financial headlines."[8] Henry C.K. Liu explains further
that "the U.S. central-bank lending rate is known as the Fed
funds rate. The Fed sets a target for the Fed funds rate, which
its Open Market Committee tries to match by lending or
borrowing in the money market ... a fiat money system set by The Bank of Japan, in Tokyo,
command of the central bank. The Fed is the head of the established in 1882.
central-bank because the U.S. dollar is the key reserve
currency for international trade. The global money market is a
USA dollar market. All other currencies markets revolve
around the U.S. dollar market." Accordingly, the U.S. situation
is not typical of central banks in general.

Typically a central bank controls certain types of short-term

interest rates. These influence the stock- and bond markets as
well as mortgage and other interest rates. The European
Central Bank, for example, announces its interest rate at the
meeting of its Governing Council; in the case of the U.S.
Federal Reserve, the Federal Reserve Board of Governors.
Both the Federal Reserve and the ECB are composed of one or
more central bodies that are responsible for the main decisions
about interest rates and the size and type of open market
operations, and several branches to execute its policies. In the
case of the Federal Reserve, they are the local Federal Reserve
Banks; for the ECB they are the national central banks.
The Reserve Bank of India
A typical central bank has several interest rates or monetary (established in 1935) Headquarters
policy tools it can set to influence markets. in Mumbai.

Marginal lending rate – a fixed rate for institutions to

borrow money from the central bank. (In the USA this is
called the discount rate).
Main refinancing rate – the publicly visible interest rate the
central bank announces. It is also known as minimum bid
The BSP Complex, in the Philippines.
rate and serves as a bidding floor for refinancing loans. (In
the USA this is called the federal funds rate).
Deposit rate, generally consisting of interest on reserves and sometimes also interest on
excess reserves – the rates parties receive for deposits at the central bank.

These rates directly affect the rates in the money market, the market for short-term loans.

Some central banks (e.g. in Denmark, Sweden and the Eurozone) are currently applying negative
interest rates.
Open market operations
Through open market operations, a central bank influences the money supply in an economy. Each
time it buys securities (such as a government bond or treasury bill), it in effect creates money. The
central bank exchanges money for the security, increasing the money supply while lowering the
supply of the specific security. Conversely, selling of securities by the central bank reduces the
money supply.

Open market operations usually take the form of:

Buying or selling securities ("direct operations") to achieve

an interest rate target in the interbank market .
Temporary lending of money for collateral securities
("Reverse Operations" or "repurchase operations",
otherwise known as the "repo" market). These operations
are carried out on a regular basis, where fixed maturity
loans (of one week and one month for the ECB) are
auctioned off.
Foreign exchange operations such as foreign exchange
swaps.

These interventions can also influence the foreign exchange

market and thus the exchange rate. For example, the People's
Bank of China and the Bank of Japan have on occasion bought The Central Bank of Brazil
several hundred billions of U.S. Treasuries, presumably in (established in 1964) in Brasília.
order to stop the decline of the U.S. dollar versus the renminbi
and the yen.

Quantitative easing
When faced with the zero lower bound or a liquidity trap,
central banks can resort to quantitative easing (QE). Like open
market operations, QE consists in the purchase of financial
assets by the central bank. There are however certain
differences: The Bank of Spain (established in
1782) in Madrid.
The scale of QE is much larger. The central bank
implementing QE usually announces a specific amount of
assets it intends to purchase.
The duration of QE is purposefully long if not open-ended.
The asset eligibility is usually wider and more flexible under QE, allowing the central bank to
purchase bonds with longer maturity and higher risk profile.

In that sense, quantitative easing can be considered as an extension of open market operations.

Reserve requirements
Historically, bank reserves have formed only a small fraction of deposits, a system called
fractional-reserve banking. Banks would hold only a small percentage of their assets in the form of
cash reserves as insurance against bank runs. Over time this process has been regulated and
insured by central banks. Such legal reserve requirements were introduced in the 19th century as
an attempt to reduce the risk of banks overextending themselves and suffering from bank runs, as
this could lead to knock-on effects on other overextended banks. See also money multiplier.

As the early 20th century gold standard was undermined by inflation and the late 20th-century fiat
dollar hegemony evolved, and as banks proliferated and engaged in more complex transactions
and were able to profit from dealings globally on a moment's notice, these practices became
mandatory, if only to ensure that there was some limit on the ballooning of money supply.

A number of central banks have since abolished their reserve requirements over the last few
decades, beginning with the Reserve Bank of New Zealand in 1985 and continuing with the Federal
Reserve in 2020. For the respective banking systems, bank capital requirements provide a check
on the growth of the money supply.

The People's Bank of China retains (and uses) more powers over reserves because the yuan that it
manages is a non-convertible currency.

Loan activity by banks plays a fundamental role in determining the money supply. The central-
bank money after aggregate settlement – "final money" – can take only one of two forms:

physical cash, which is rarely used in wholesale financial markets,

central-bank money which is rarely used by the people

The currency component of the money supply is far smaller than the deposit component. Currency,
bank reserves and institutional loan agreements together make up the monetary base, called M1,
M2 and M3. The Federal Reserve Bank stopped publishing M3 and counting it as part of the
money supply in 2006.[9]

Capital requirements
All banks are required to hold a certain percentage of their assets as capital, a rate which may be
established by the central bank or the banking supervisor. For international banks, including the
55 member central banks of the Bank for International Settlements, the threshold is 8% (see the
Basel Capital Accords) of risk-adjusted assets, whereby certain assets (such as government bonds)
are considered to have lower risk and are either partially or fully excluded from total assets for the
purposes of calculating capital adequacy. Partly due to concerns about asset inflation and
repurchase agreements, capital requirements may be considered more effective than reserve
requirements in preventing indefinite lending: when at the threshold, a bank cannot extend
another loan without acquiring further capital on its balance sheet.

Credit guidance and controls

Central banks can directly control the money supply by placing limits on the amount banks can
lend to various sectors of the economy.[10][11] Central banks can also control the amount of lending
by applying credit quotas. This allows the central bank to control both the quantity of lending and
its allocation towards certain strategic sectors of the economy, for example to support the national
industrial policy. The Bank of Japan used to apply such policy ("window guidance") between 1962
and 1991.[12][13]
Exchange requirements
To influence the money supply, some central banks may require that some or all foreign exchange
receipts (generally from exports) be exchanged for the local currency. The rate that is used to
purchase local currency may be market-based or arbitrarily set by the bank. This tool is generally
used in countries with non-convertible currencies or partially convertible currencies. The recipient
of the local currency may be allowed to freely dispose of the funds, required to hold the funds with
the central bank for some period of time, or allowed to use the funds subject to certain restrictions.
In other cases, the ability to hold or use the foreign exchange may be otherwise limited.

In this method, money supply is increased by the central bank when it purchases the foreign
currency by issuing (selling) the local currency. The central bank may subsequently reduce the
money supply by various means, including selling bonds or foreign exchange interventions.

Margin requirements and other tools

In some countries, central banks may have other tools that work indirectly to limit lending
practices and otherwise restrict or regulate capital markets. For example, a central bank may
regulate margin lending, whereby individuals or companies may borrow against pledged securities.
The margin requirement establishes a minimum ratio of the value of the securities to the amount
borrowed.

Central banks often have requirements for the quality of assets that may be held by financial
institutions; these requirements may act as a limit on the amount of risk and leverage created by
the financial system. These requirements may be direct, such as requiring certain assets to bear
certain minimum credit ratings, or indirect, by the central bank lending to counterparties only
when security of a certain quality is pledged as collateral.

Limits on policy effects

Although the perception by the public may be that the "central bank" controls some or all interest
rates and currency rates, economic theory (and substantial empirical evidence) shows that it is
impossible to do both at once in an open economy. Robert Mundell's "impossible trinity" is the
most famous formulation of these limited powers, and postulates that it is impossible to target
monetary policy (broadly, interest rates), the exchange rate (through a fixed rate) and maintain
free capital movement. Since most Western economies are now considered "open" with free capital
movement, this essentially means that central banks may target interest rates or exchange rates
with credibility, but not both at once.

In the most famous case of policy failure, Black Wednesday, George Soros arbitraged the pound
sterling's relationship to the ECU and (after making $2 billion himself and forcing the UK to spend
over $8bn defending the pound) forced it to abandon its policy. Since then he has been a harsh
critic of clumsy bank policies and argued that no one should be able to do what he did.

The most complex relationships are those between the yuan and the US dollar, and between the
euro and its neighbors. US dollars were ubiquitous in Cuba's economy after its legalization in 1991
but were officially removed from circulation in 2004 and replaced by the convertible peso.

Forward guidance
More radical instruments
Some have envisaged the use of what Milton Friedman once called "helicopter money" whereby the
central bank would make direct transfers to citizens[14] 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.[15]

Banking supervision and other activities

In some countries a central bank, through its subsidiaries, controls and monitors the banking
sector. In other countries banking supervision is carried out by a government department such as
the UK Treasury, or by an independent government agency, for example, UK's Financial Conduct
Authority. It examines the banks' balance sheets and behaviour and policies toward consumers.
Apart from refinancing, it also provides banks with services such as transfer of funds, bank notes
and coins or foreign currency. Thus it is often described as the "bank of banks".

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.

Independence
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 Deutsche
Bundesbank 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.

Advocates of central bank independence argue that a central bank which is too susceptible to
political direction or pressure may encourage economic cycles ("boom and bust"), as politicians
may be tempted to boost economic activity in advance of an election, to the detriment of the long-
term health of the economy and the country. In this context, independence is usually defined as the
central bank's operational and management independence from 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.[16] Generally, independent central banks enjoy
both goal and instrument independence.[17]

In return to their independence, central bank 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,[18]
publishes verbatim transcripts, and balance sheets are audited by the Government Accountability
Office.[19]

In the 1990s there was a trend towards increasing the independence of central banks as a way of
improving long-term economic performance.[20] 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.[21]

The literature on central bank independence has defined a cumulative and complementary number
of aspects:[22][23]

Institutional independence: The independence of the central bank is enshrined in law and
shields central bank from political interference. In general terms, institutional independence
means that politicians should refrain to seek to influence monetary policy decisions, while
symmetrically central banks should also avoid influencing government politics.
Goal independence: The central bank has the right to set its own policy goals, whether
inflation targeting, control of the money supply, or maintaining a fixed exchange rate. While this
type of independence is more common, many central banks prefer to announce their policy
goals in partnership with the appropriate government departments. This increases the
transparency of the policy-setting process and thereby increases the credibility of the goals
chosen by providing assurance that they will not be changed without notice. In addition, the
setting of common goals by the central bank and the government helps to avoid situations
where monetary and fiscal policy are in conflict; a policy combination that is clearly sub-
optimal.
Functional & operational independence: The central bank has the independence to
determine the best way of achieving its policy goals, including the types of instruments used
and the timing of their use. To achieve its mandate, the central bank has the authority to run its
own operations (appointing staff, setting budgets, and so on.) and to organize its internal
structures without excessive involvement of the government. This is the most common form of
central bank independence. The granting of independence to the Bank of England in 1997
was, in fact, the granting of operational independence; the inflation target continued to be
announced in the Chancellor's annual budget speech to Parliament.
Personal independence: The other forms of independence are not possible unless central
bank heads have a high security of tenure. In practice, this means that governors should hold
long mandates (at least longer than the electoral cycle) and a certain degree of legal
immunity.[24] One of the most common statistical indicators used in the literature as a proxy for
central bank independence is the "turn-over-rate" of central bank governors. If a government is
in the habit of appointing and replacing the governor frequently, it clearly has the capacity to
micro-manage the central bank through its choice of governors.
Financial independence: central banks have full autonomy on their budget, and some are
even prohibited from financing governments. This is meant to remove incentives from
politicians to influence central banks.
Legal independence: some central banks have their own legal personality, which allows them
to ratify international agreements without government's approval (like the ECB) and to go in
 court.

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.[25] 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.
Even the People's Bank of China has been accorded great latitude, though in China the official role
of the bank remains that of a national bank rather than a central bank, underlined by the official
refusal to "unpeg" the yuan or to revalue it "under pressure". The People's Bank of China's
independence can thus be read more as independence from the US, which rules the financial
markets, rather than from the Chinese Communist Party which rules the country. The fact that the
Communist Party is not elected also relieves the pressure to please people, increasing its
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.

History

Early history
The use of money as a unit of account predates history. Government control of money is
documented in the ancient Egyptian economy (2750–2150 BCE).[26] The Egyptians measured the
value of goods with a central unit called shat. As many other currencies, the shat was linked to
gold. The value of a shat in terms of goods was defined by government administrations. Other
cultures in Asia Minor later materialized their currencies in the form of gold and silver coins.[27]

In the medieval and the early modern period a network of professional banks was established in
Southern and Central Europe.[28] The institutes built a new tier in the financial economy. The
monetary system was still controlled by government institutions, mainly through the coinage
prerogative. Banks, however, could use book money to create deposits for their customers. Thus,
they had the possibility to issue, lend and transfer money autonomously without direct
governmental control.

In order to consolidate the monetary system, a network of public exchange banks was established
at the beginning of the 17th century in main European trade centres. The Amsterdam Wisselbank
was founded as a first institute in 1609. Further exchange banks were located in Hamburg, Venice
and Nuremberg. The institutes offered a public infrastructure for cashless international
payments.[29] They aimed to increase the efficiency of international trade and to safeguard
monetary stability. The exchange banks thus fulfilled comparable functions to modern central
banks.[30] The institutes even issued their own (book) currency, called Mark Banco.
Bank of Amsterdam (Amsterdamsche Wisselbank)
In the early modern period, the Dutch were pioneering
financial innovators who developed many advanced
techniques and helped lay the foundations of modern financial
systems.[31] The Bank of Amsterdam (Amsterdam
Wisselbank), established in the Dutch Republic in 1609, was a
forerunner to modern central banks. The Wisselbank's
innovations helped lay the foundations for the birth and
development of the central banking system that now plays a
vital role in the world's economy. Along with a number of
subsidiary local banks, it performed many functions of a The old town hall in Amsterdam
central banking system.[32] The model of the Wisselbank as a where the Bank of Amsterdam was
founded in 1609, painting by Pieter
state bank was adapted throughout Europe, including Sveriges
Saenredam.
Riksbank (1668) and the Bank of England (1694).

Sveriges Riksbank
Established by Dutch-Latvian Johan Palmstruch in 1668, Sweden's central bank, the Riksbank, is
often considered by many as the world's oldest central bank. However it lacked a central function
before 1904 since it did not have a monopoly over issuing bank notes.[33]

Bank of England
The establishment of the Bank of England, the model on which
most modern central banks have been based, was devised by
Charles Montagu, 1st Earl of Halifax, in 1694, following a
proposal by the banker William Paterson three years earlier,
which had not been acted upon.[34] In the Kingdom of England
in the 1690s, public funds were in short supply, and the credit
of William III's government was so low in London that it was
impossible for it to borrow the £1,200,000 (at 8 percent)
needed to finance the ongoing Nine Years' War with France. In
order to induce subscription to the loan, Montagu proposed Sealing of the Bank of England
that the subscribers were to be incorporated as The Governor Charter (1694), by Lady Jane
and Company of the Bank of England with long-term banking Lindsay, 1905.
privileges including the issue of notes. The lenders would give
the government cash (bullion) and also issue notes against the
government bonds, which could be lent again. A Royal Charter was granted on 27 July through the
passage of the Tonnage Act 1694.[35] The bank was given exclusive possession of the government's
balances, and was the only limited-liability corporation allowed to issue banknotes.[36] The £1.2M
was raised in 12 days; half of this was used to rebuild the Navy.

Although this establishment of the Bank of England marks the origin of central banking, it did not
have the functions of a modern central bank, namely, to regulate the value of the national currency,
to finance the government, to be the sole authorized distributor of banknotes, and to function as a
'lender of last resort' to banks suffering a liquidity crisis. These modern central banking functions
evolved slowly through the 18th and 19th centuries.[37]
Although the Bank was originally a private institution, by the end of the 18th century it was
increasingly being regarded as a public authority with civic responsibility toward the upkeep of a
healthy financial system. The currency crisis of 1797, caused by panicked depositors withdrawing
from the Bank led to the government suspending convertibility of notes into specie payment.[38]
The bank was soon accused by the bullionists of causing the exchange rate to fall from over issuing
banknotes, a charge which the Bank denied. Nevertheless, it
was clear that the Bank was being treated as an organ of the
state.

Henry Thornton, a merchant banker and monetary theorist

has been described as the father of the modern central bank.
An opponent of the real bills doctrine, he 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
The Bank of England, established in form". As a response to the 1797 currency crisis, Thornton
1694. 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.[39]

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.[40] Many
consider the origins of the central bank to lie with the passage
of the Bank Charter Act 1844.[37] Under the 1844 Act,
bullionism was institutionalized in Britain,[41] creating a ratio
between the gold reserves held by the Bank of England and the
notes that the Bank could issue.[42] The Act also placed strict
curbs on the issuance of notes by the country banks.[42]

The Bank accepted the role of 'lender of last resort' in the

1870s after criticism of its lacklustre response to the Overend-
Gurney crisis. The journalist Walter Bagehot wrote on the
subject in Lombard Street: A Description of the Money
Market, in which he advocated for the Bank to officially
become a lender of last resort during a credit crunch, Walter Bagehot, an influential theorist
sometimes referred to as "Bagehot's dictum". Paul Tucker on the economic role of the central
bank.
phrased the dictum in 2009 as follows:

…to avert panic, central banks should lend early

and freely (ie without limit), to solvent firms,
against good collateral, and at 'high rates'.[43]

Spread around the world

Central banks were established in many European countries during the 19th century.[44][45]
Napoleon created the Banque de France in 1800, in an attempt to improve the financing of his
wars.[46] On the continent of Europe, the Bank of France remain the most important central bank
throughout the 19th century. A central banking role was played by a small group of powerful family
banking houses, typified by the House of Rothschild, with branches in major cities across Europe,
as well as the Hottinguer family in Switzerland and the Oppenheim family in Germany.[47][48]

Although central banks today are generally associated with fiat money, the 19th and early 20th
centuries central banks in most of Europe and Japan developed under the international gold
standard. Free banking or currency boards were common at this 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, most notably in Australia.

Australia established its first central bank in 1920, Peru in 1922, Colombia in 1923, Mexico and
Chile in 1925 and Canada, India and New Zealand in the aftermath of the Great Depression in
1934. By 1935, the only significant independent nation that did not possess a central bank was
Brazil, which subsequently developed a precursor thereto in 1945 and the present Central Bank of
Brazil twenty years later. After gaining independence, 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.

The People's Bank of China evolved its role as a central bank

starting in about 1979 with the introduction of market reforms,
which accelerated in 1989 when the country adopted a
generally capitalist approach to its export economy. Evolving
further partly in response to the European Central Bank, the
People's Bank of China had by 2000 become a modern central
bank. The most recent bank model was introduced together
with the euro, and involves coordination of the European
national banks, which continue to manage their respective The headquarters of the People's
economies separately in all respects other than currency Bank of China (established in 1948)
exchange and base interest rates. in Beijing.

United States
Alexander Hamilton as Secretary of the Treasury in the 1790s strongly promoted the banking
system, and over heavy opposition from Jeffersonian Republicans, set up the First Bank of the
United States. Jeffersonians allowed it to lapse, but the overwhelming financial difficulties of
funding the War of 1812 without a central bank changed their minds. The Second Bank of the
United States (1816–1836) under Nicholas Biddle functioned as a central bank, regulating the
rapidly growing banking system.[49] The role of a central bank was ended in the Bank War of the
1830s by President Andrew Jackson when he shut down the Second Bank as being too powerful
and elitist.[50]

In 1913 the United States created the Federal Reserve System through the passing of The Federal
Reserve Act.[51]

Naming of central banks

There is no standard terminology for the name of a central bank, but many countries use the "Bank
of [Country]" form—for example: Bank of Canada, Bank of Mexico, Bank of Thailand. The United
Kingdom does not follow this form as its central bank is the Bank of England (which, despite its
name, is the central bank of the United Kingdom as a whole). The name's lack of representation of
the entire United Kingdom ('Bank of Britain', for example) can be owed to the fact that its
establishment occurred when the Kingdoms of England, Scotland and Ireland were separate
entities (at least in name), and therefore pre-dates the merger of the Kingdoms of England and
Scotland, the Kingdom of Ireland's absorption into the Union and the formation of the present day
United Kingdom.

The word "Reserve" is also often included, such as the Reserve Bank of India, Reserve Bank of
Australia, Reserve Bank of New Zealand, the South African Reserve Bank, and Federal Reserve
System. Other central banks are known as monetary authorities such as the Saudi Arabian
Monetary Authority, Hong Kong Monetary Authority, Monetary Authority of Singapore, Maldives
Monetary Authority and Cayman Islands Monetary Authority. There is an instance where native
language was used to name the central bank: in the Philippines the Filipino name Bangko Sentral
ng Pilipinas is used even in English.

Some are styled "national" banks, such as the Swiss National Bank, National Bank of Poland and
National Bank of Ukraine, although the term national bank is also used for private commercial
banks in some countries such as National Bank of Pakistan. In other cases, central banks may
incorporate the word "Central" (for example, European Central Bank, Central Bank of Ireland,
Central Bank of Brazil). In some countries, particularly in formerly Communist ones, the term
national bank may be used to indicate both the monetary authority and the leading banking entity,
such as the Soviet Union's Gosbank (state bank). In rare cases, central banks are styled "state"
banks such as the State Bank of Pakistan and State Bank of Vietnam.

Many countries have state-owned banks or other quasi-government entities that have entirely
separate functions, such as financing imports and exports. In other countries, the term national
bank may be used to indicate that the central bank's goals are broader than monetary stability,
such as full employment, industrial development, or other goals. Some state-owned 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.

The chief executive of a central bank is usually known as the Governor, President or Chair.

21st century
After the financial crisis of 2007–2008 central banks led change, but as of 2015 their ability to
boost economic growth has stalled. Central banks debate whether they should experiment with
new measures like negative interest rates or direct financing of government, "lean even more on
politicians to do more". Andy Haldane from the Bank of England said "central bankers may need to
accept that their good old days – of adjusting interest rates to boost employment or contain
inflation – may be gone for good". The European Central Bank and the Bank of Japan whose
economies are in or close to deflation, continue quantitative easing – buying securities to
encourage more lending.[52]

Since 2017, prospect of implementing Central Bank Digital Currency (CBDC) has been in
discussion.[53] As of the end of 2018, at least 15 central banks were considering to implementing
CBDC.[54] Since 2014, the People's Bank of China has been working on a project for digital
currency to make its own digital currency and electronic payment systems.[55][56]
Statistics
Collectively, central banks purchase less than 500 tonnes of gold each year, on average (out of an
annual global production of 2,500-3,000 tonnes per year).[58] In 2018, central banks collectively
hold over 33,000 metric tons of the gold, about a fifth of all the gold ever mined, according to
Bloomberg News.[59]

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
U.K., 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.[60]

Top 5 Largest Central Bank by Total Assets[61]

Rank Central Bank Profile Total Assets

1 People's Bank of China $5,196,560,000,000

2 Bank of Japan $4,945,440,000,000

3 Federal Reserve System $3,857,715,000,000

4 Bank of Spain $861,564,000,000

5 Central Bank of Brazil $856,248,000,000

Criticism

Libertarian criticisms
Certain groups of people, like Libertarians, believe central banking is an incompetent cartel that
does very little to prevent recessions. Milton Friedman for example has claimed the Federal
Reserve, which had been founded in 1913, contributed to worsening the Great Depression by
artificially keeping interest rates too low and then suddenly shocking the system with outrageously
high rates. Although Friedman was a monetarist, he believed decisions regarding interest rates
should be left to computers, similar to the way the modern stock market is heavily automated.

Individuals who support free banking believe that fiat money should not exist, but that currencies
should be freely traded in the economy, and indexing those currencies to precious commodities.

See also
List of central banks
History of central banking in the United States
Fractional-reserve banking
Free banking
Full-reserve banking

Notes and references

1. Compare: Uittenbogaard, Roland (2014). Evolution of Central Banking?: De Nederlandsche
 1. Compare: Uittenbogaard, Roland (2014). Evolution of Central Banking?: De Nederlandsche
Bank 1814 -1852 (https://books.google.com/books?id=YlkEBgAAQBAJ). Cham (Switzerland):
Springer. p. 4. ISBN 9783319106175. Retrieved 3 February 2019. "Although it is difficult to
define central banking, [...] a functional definition is most useful. [...] Capie et al. (1994) define a
central bank as the government's bank, the monopoly note issuer and lender of last resort."
2. 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."
3. "Public governance of central banks: an approach from new institutional economics" (https://w
ww.bis.org/publ/work299.pdf) (PDF). The Bulletin of the Faculty of Commerce. 89 (4). March
2007.
4. Apel, Emmanuel (November 2007). "1". Central Banking Systems Compared: The ECB, The
Pre-Euro Bundesbank and the Federal Reserve System. Routledge. p. 14. ISBN 978-
0415459228.
5. "Ownership and independence of FED" (https://www.federalreserve.gov/faqs/about_14986.htm
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6. Deutsche Bundesbank#Governance
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8. How the US Money Market Really Works (https://henryckliu.com/page16.html) (Part III of
"Greenspan - the Wizard of Bubbleland" (http://henryckliu.com/page14.html)). By Henry C.K.
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m3.htm). press release. Federal Reserve Board. Retrieved 9 March 2006.
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they Do', Asian Economic Journal, vol. 16 no.2, Oxford: Blackwell, pp. 111–151; Werner,
Richard (2001). Princes of the Yen, Armonk: M. E. Sharpe [1] (https://books.google.com/books
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to raise and lend money to the State and in consideration of this service it received under its
Charter and various Act of Parliament, certain privileges of issuing bank notes. The corporation
 Charter and various Act of Parliament, certain privileges of issuing bank notes. The corporation
commenced, with an assured life of twelve years after which the Government had the right to
annul its Charter on giving one year's notice. '''Subsequent extensions of this period coincided
generally with the grant of additional loans to the State'''"
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Further reading
Acocella, N., Di Bartolomeo, G., and Hughes Hallett, A. [2012], "Central banks and economic
policy after the crisis: what have we learned?", ch. 5 in: Baker, H. K. and Riddick, L. A. (eds.),
Survey of International Finance, Oxford University Press.

External links
List of central bank websites at the Bank for International Settlements (http://www.bis.org/cban
ks.htm)
International Journal of Central Banking (http://www.ijcb.org/)
"The Federal Reserve System: Purposes and Functions" (https://www.federalreserve.gov/pf/pf.
htm) – A publication of the U.S. Federal Reserve, describing its role in the macroeconomy
A hundred ways to skin a cat: comparing monetary policy operating procedures in the United
States, Japan and the euro area (http://www.bis.org/publ/bppdf/bispap09a.pdf) (PDF). (176 KB)
– C E V Borio, Bank for International Settlements, Basel

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