Central Bank

Definition

A Central Bank is a national institution responsible for overseeing the monetary system and regulating the money supply of a nation (or a group of nations). * Often called the "Bank of Banks," it does not deal with regular customers but works with commercial banks and the government. * Examples: Federal Reserve (The Fed) in the US, Bank of England (BoE), Bank of Korea (BOK).

Primary Mandate: Monetary Policy

The central bank's main tool is Monetary Policy, usually managed by adjusting Interest Rates. * Fighting Inflation (Hawkish): When prices rise too fast, the central bank raises interest rates to cool down spending and borrowing. * Boosting Growth (Dovish): When the economy is sluggish, it lowers rates to encourage borrowing and investment. * The Fed's Dual Mandate: Specifically for the US Federal Reserve, they have two equal goals: Maximum Employment and Stable Prices.

Functions

1. Issuing Currency: It is the only entity legally authorized to print banknotes (Fiat Money).
2. Lender of Last Resort: During financial panics, it provides emergency liquidity to commercial banks to prevent a systemic collapse (e.g., bank runs).
3. Gold Reserves: It manages the nation's foreign exchange and gold reserves to stabilize the currency value.

Why Independence Matters

A central bank must be insulated from short-term political pressures. * If politicians controlled the printing press, they might print excessive money to fund popularity projects, leading to currency debasement and hyperinflation.