Central Banking

A Central Bank is a 'printer press' of money. It has the power to decide how much money is issued and where it is allocated. It uses those powers to achieve its mandates of monetary stability and financial stability by its own plan that is called monetary policy (the FED has also the mandate of achieving maximum employment).

Modern Central Banks usually consider monetary stability as a low domestic consumer price inflation and a stable exchange rate against the main other currencies.

Financial stability is considered the smoothly run of the financial system (in short-term).

Modern convencional monetary policy implementation process:

1st. Announcement of interest rate policy: the Central Bank makes public its target figure for the interest rate that commercial banks charge each other overnight when lending reserve balances (Federal funds rate, LIBOR, etc.). Speculators will tend to led rates to that figure knowing that if not, the Central Bank can always step in through open market operations.

2nd. Open market operations: the Central Bank creates money and uses it to purchase government securities in the Money Market (the market for short-term debt), which influences overnight interest rate. There are outright transactions and repo transactions.

3rd. Standing facilities or Discount window: the Central Bank establishes a lending facility just in case any bank finds difficulties borrowing. The rate charged is usually the interest rate announced plus a small premium (+ 0.5% approx).

It is also common for the Central Bank to negotiate other financial assets or treasuries (like gold, bonds from other countries, and foreign currencies) to intervene in the exchange rate or acquire the necessary tools for this.

Non-conventional monetary policy implementation includes Quantitative Easing and may also include Credit Easing.

Quantitative Easing it is the purchasing of long-maturity government securities. It lowers long-term borrowing costs and restores liquidity.

Credit Easing is the purchasing of private sector securities.

A Central Bank also regulates financial entities and acts as a lender of last resort to them, especially to those considered “too-big-to-fail” or “too-connected-to-fail”.

 

The interest it earns through its assets is remitted to the government, although part is used to cover wages and costs.