The Role of a Central Bank

We hear about Interest Rates and the Fed and what not. But what really is the role of a Central Bank


The Economics Amateur

3 years ago | 4 min read

First and foremost, what is a Central Bank ?

The Central Bank is not like any other bank in an economy. It is an independent institution controlling the supply of money in an economy and the amount of credit available. It acts as a regulator in the economy’s growth rate to make sure the economy is at the optimum temperature, not too hot and not too cold either.

In Malaysia the Central Bank is Bank Negara. In the US, its the Federal Reserve. UK’s is called the Bank of England.

The EU is a special case. Because most EU members (19 out of 27) use the Euro as a common currency, each of them have their own Central Bank and an overall Central Bank called the European Central Bank (ECB).

The Central Bank also has to develop policies to control Money in the economy. The policy’s name is Monetary Policy.

So let me elaborate more on the roles, duties of a Central Bank.

Printing Money

Central Banks are THE ONLY institution which can print money in an economy. Any other printer of money is in violation of the law.

To be more specific, a country’s central bank can only print its own currency. Makes sense right ?
We can’t be having the Bank of Canada printing US Dollars and the Bank of England printing Japanese Yen because it is not their jurisdiction to control the currency of others.

But they can hold the currency of other countries. For example, most Central Banks store US Dollars in their reserve. Why ? You’ll know in the next point. But back to Printing Money.

Money printing doesn’t just happen anytime the Central Bank feels like doing it. The Central Bank has to consider the supply of money in the economy, is it not enough or is it too much ? They also have to base it off their reserve. The reserve of a Central Bank could consist of Foreign Exchange notes or assets like Gold Bars.

So the value of these assets should roughly equal the total amount of money in the Economy.

The Queen checking out Gold Bars stored in the vault of the Bank of England (UK’s Central Bank). Source: Business Insider
The Queen checking out Gold Bars stored in the vault of the Bank of England (UK’s Central Bank). Source: Business Insider

Controlling the Exchange Rate

If you do not know the ways a currency exchanges with another currency, click here. You might need some base knowledge first.

Sometimes, the Central Bank recognizes the need for a higher or lower Exchange Rate hence they buy and sell Foreign Currency in their reserves. (Remember the FOREX mentioned above ?)

So, if China wants to have much depreciated currency, they would buy more US Dollars using their Ren Min Bi. Thus, the Ren Min Bi depreciates against the USD and the goal is achieved.

*Why depreciate ? To make exports cheaper and imports more costly. Click here to find out the Benefits of Currency Depreciation.
**Why USD ? Most of the world’s international trade transactions is priced in USD. (52% in 2014)

However, this act is usually not done regularly and most Central Banks tend to leave it to the market, only acting when absolutely required. Because artificially manipulating the exchange rate or what is called a “Dirty Float”, can spark outrage among economies.

Take China for instance, its giant Export value ran on a basis of how cheap its goods were. One of the reasons was because it ran a dirty float which the US has accused them of, causing a trade war. Click here to read about China’s Little Trick.

Another way to manage the Exchange Rate is through Interest Rates.

Monetary Policies

And as we all know, Central Banks set Interest Rates in the economy. They do this to ensure Inflation at high rates do not happen.

It also acts as an incentive or disincentive for the economy growth rate. In short,
Low interest rates when they need it to grow at a greater rate.
High interest rates when they want things to slow down a bit.

It can also affect the Exchange Rate. High Interest Rates usually cause Appreciation in the currency and vice versa.

To find out the whole story behind Interest Rates, I have written a comprehensive post on the Money Policies of an Economy. Click here, it is a good read for beginners.


I won’t get into this part much. But Central Banks do also lend money to Commercial Banks like HSBC, Standard Chartered, Maybank etc.

They ALSO lend to states and governments. So, if the US government needs to borrow some funds, they can issue BONDS. The Central Banks buy those bonds from the US government. Hence, money reaches the hand of the US government and the bond is owned by the Central Bank.

*Bonds are like an “I owe you” paper. Basically a different form of lending. The US government has to repay the Central Bank in future.

Big role indeed

So it is clear, the Central Bank does play a big big role in the economy especially flows of money in, out and within an economy.

But it might play a bigger role in the future. Innovations towards Central Banking is called for in recent years to be more technologically advanced and be suited to the uprising of Financial Technology aka Fintech.

One way is a digital currency. China has started implementing it. President of the ECB, Christine Lagarde says the Euro Zone could implement the digital currency in the next 5-10 years.

Change always seems to occur in any field, Central Banks included.

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The Economics Amateur







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