History and Function of Central Banks

Study Notes

History of Central Banks

The Swedish Riksbank, established in 1668, is considered the first recognized central bank.
The Bank of England, founded in 1694, is known as a prominent central bank of its era.
The Federal Reserve System was established in the early 20th century to consolidate currency instruments and promote financial stability.
The Banque de France was created by Napoleon in 1800 to support economic recovery following the French Revolution.
The Federal Reserve was created by the US Congress in 1913.
The Bank of Canada was established in 1935 to standardize money production.
The German Bundesbank was re-established after World War II.
The European Central Bank replaced all eurozone central banks in 1998.

How Central Banks Work

Central banks have the sole authority to print and circulate banknotes, as well as withdraw and destroy them.
Central banks conduct monetary policy by adjusting the money supply to stimulate economic growth.
The primary objective of a central bank is to stabilize a nation's currency and prevent inflation.
Maintaining price stability is the core function of monetary policy.
Open market operations are designed to influence short-term interest rates.
Central banks are responsible for administering a country's gold and currency reserves.

Central Bank Functions in the Economy

Base Rate: The interest rate at which commercial banks can borrow from the central bank. Increasing the base rate makes borrowing more expensive for commercial organizations.
Open Market Operations: Involve the central bank creating money and purchasing financial assets.
Reserve Requirements: Central bank regulations that set a minimum proportion of commercial bank liabilities that must be held as reserves.
Foreign Exchange Reserves: Foreign currency held by a country's central bank to stabilize fluctuations in the foreign exchange market.

Major Central Banks Around the World

US Federal Reserve (Fed): Established in 1913, it's the most influential central bank globally. The US dollar is used for approximately 90% of global currency transactions, making the Fed's impact significant. It consists of:
- Board of Governors: Operates independently of the US government, reporting directly to Congress.
- Federal Reserve Banks: 12 regional banks overseeing different parts of the US, located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco.
- Federal Open Market Committee (FOMC): Comprises Board members and presidents of the 12 reserve banks, meeting eight times a year to discuss economic conditions, financial stability, and monetary policy.
European Central Bank (ECB): Established in 1998, it's the governing body for the Eurozone countries. The Governing Council decides on monetary policy changes. The Council consists of six Executive Board members and governors from the 19 Eurozone countries. Meetings occur biweekly with press conferences held eleven times a year.
Bank of England (BOE): Publicly owned and accountable to the British people through Parliament. Founded in 1694, it's considered one of the most effective central banks. The Monetary Policy Committee, composed of nine members, including the governor, deputy governors, and external experts, meets eight times a year to announce policy decisions.
Bank of Japan (BOJ): Began operating in 1882, focusing on price stability and financial system stability, with inflation as a key concern.