Central Banking and Money Supply
Most people believe that central banks are government owned but separate from the country’s ministry of finance. That is only true in a small number of countries. The central bank for the United Kingdom (UK), the Bank of England, and the United States of America (USA, the Federal Reserve, are in fact private organisations.
You may wonder then why these central banks along with the central bank of the European Union (EU), the European Central Bank and the Australian central bank, the Reserve Bank of Australia want people to think they are part of government. Think about it. If you were a private organisation and you controlled the money supply of a country, would you want the people to fully understand that your business is about making money (profit) from government debt? And more importantly as a private company whose interest will you look after first, the people or your shareholders?
If you fully grasp that then you can understand why these central banks like to fly under the radar when it comes to there separation from government and hence the people that the government is supposed to serve.
The central bank is frequently termed the “government’s bank” because it handles the buying and selling of government bonds and other instruments, political decisions should not influence central bank operations. Of course, the nature of the relationship between the central bank and the ruling regime varies from country to country and continues to evolve with time. To ensure the stability of a country’s currency, most central banks are the regulator and authority in the banking and monetary systems.
- European Central Bank
Historically, the role of the central bank has been growing, some may argue, since the establishment of the Bank of England in 1694. It is, however, generally agreed upon that the concept of the modern central bank did not appear until the 20th century as problems developed in the commercial banking system. Thus, the central bank’s modern function emerged in response to an already present commercial banking structure.
Between 1870 and 1914, when world currencies were pegged to the gold standard (GS), maintaining price stability was a lot easier because the amount of gold available was limited. Consequently, monetary expansion could not occur simply from a political decision to print more money, so inflation was easier to control. The central bank at that time was primarily responsible for maintaining the convertibility of gold into currency, it issued notes based on a country’s reserves of gold.
At the outbreak of World War I (WWI), the GS was abandoned, and it came apparent that, in times of crisis, governments, facing budget deficits (because it costs money to wage war) and needing greater resources, will order the printing of more money. As governments did so, they encountered inflation. After WWI, many governments opted to go back to the GS to try to stabilize their economies. With this rose the awareness of the importance of the central bank’s independence from the political machine.
Next week we’ll look at how the central bank influences the economy through macro and micro economics.
4Quan
Warrior for Truth
Professor (things that make you go Hmm..)