Today, almost every country on earth controls the flow of money through its financial system using a central bank. Acting as rocks of stability, many central banks were originally founded solely to finance large-scale government spending. Yet, in most cases, the roles and responsibilities of central banks have evolved far beyond their initial objectives with many becoming an integral part of economic policy to better manage a country’s financial health.

With that in mind, let’s explore the multi-faceted role of a central bank, its importance, and how the institution’s actions influence prices, mortgage rates and more. 

The main functions of a central bank:

Monetary policy, money supply, interest rates and more

As the only body with power to issue banknotes, central banks effectively control a nation’s money supply, meaning they can introduce more money into the economy in the form of new bills. This process influences the cost of goods and services as introducing additional funds into the economy can cause prices to rise. Known as quantitative easing, central banks often increase the money supply to provide domestic banks with greater lending capacity, boosting overall economic activity.

Another tool at the central bank’s disposal to influence both prices and economic growth is the setting of interest rates. By governing the cost of borrowing money, central banks can either raise interest rates to control price rises or drop them to spur consumption and economic growth. These changes particularly affect mortgage holders, graduates with hefty student loans as well as any individual or business looking to borrow money.

Central banks & Governments:

Bonds, reserve requirement and emergency credit

Many major central banks can trace their roots back to bonds and credit. Important examples include the Bank of England and the Bank of France – in fact, the UK government founded the Bank of England in 1694 by offering the newly established central bank exclusive rights to issue banknotes on the premise that it would provide a £1.2 million loan to rebuild the Royal Navy. In this respect, the role of a nation’s leading financial body has altered little over time with central banks consistently providing governments with emergency funding.

Central banks can do this in several ways. They can simply lend the government money, buy government bonds and deposit funds into the treasury’s coffers, or reduce the amount of money being kept in reserve. All these methods mean that if a country faces an unexpected crisis, a government can access the funds it needs, allowing it to support its population. For instance, in response to the coronavirus pandemic, the US Federal Reserve reduced the amount of money it legally had to keep in reserve to 0%, freeing up additional funds for pandemic recovery programs.

Controlling currency value:

Currency management, economic research and data analysis

 By managing the exchange rate for their national currency, central banks can effectively control its value. As mentioned, interest rates determine borrowing costs, but they also influence exchange rates by indicating the demand for a particular currency. For instance, the US Federal Reserve raised interest rates in 2022 to strengthen the US dollar relative to other currencies. As a result, commodities traded in US dollars on global markets, such as gas and oil, increased in price. 

Central banks can also influence exchange rates by purchasing or selling foreign currencies. Typically, they’ll buy or sell foreign currency reserves in exchange for domestic banknotes to boost trade or maintain stable prices. Some countries even peg their currencies to the value of others. For example, many African currencies are pegged to the Euro to prevent volatile fluctuations in their value.

Equally, central banks often serve as economic research hubs, providing governments with insightful financial data. This research-driven approach has led to important discoveries such as the adoption of forward guidance, a concept that involves central banks informing populations about interest rate changes prior to any adjustments. Through forward guidance, households and businesses have more time to plan accordingly.

By fulfilling this research role, central banks can assist policymakers in creating stable financial conditions, boosting the overall economic well-being of the nation.

Maintaining financial stability:

Regulation and the lender of last resort

Before the adoption of central banking, fluctuations in global prices often led to panics that quickly spiraled into financial crises. Back in 1837, a sudden change in the price of cotton resulted in a wider economic depression in the United States, a situation that potentially could have been avoided with the immediate introduction of emergency funds. This process, known as the Lender of Last Resort, is where the central bank intervenes to avoid the failure of a particular bank or financial institution where it feels that a sudden collapse could have a systemic impact. This safety net is a major tool in preventing recessions and maintaining public confidence in the financial sector.

In recent decades, this power has been extended to include regulation. Acting as vigilant watchdogs of other financial institutions in the country, many central banks analyze commercial bank figures and perform on-site inspections. The combination of these two roles helps to ensure access to honest and robust financial services.

Central Banks & Ria Money Transfer

As a trusted and transparent money transfer company with more than 35 years of experience in the industry, we work closely with central banks and regulators to ensure that your remittance transfers are fast, secure, and convenient. This reputation for providing a timely and responsible service has enabled us to expand our offering, connecting customers with loved ones in more than 190 countries and territories across the globe. 

Ready to send money? Download the Ria Money Transfer app for iOS and Android today! 

For more info: comms@riamoneytransfer.com