What Is The Purpose Of A Central Bank?

The main purpose of major central banks is using their policy tools to achieve their mandates.
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We just have a quick question here from a new subscriber asking what the actual purpose is of a central bank, who puts them in charge and what do they really do?

So great question, let’s quickly unpack this for you so firstly, think of a central bank as the people who are responsible for overseeing and protecting the monetary system of any particular country.

So the major central banks from developed economies usually pride themselves on their independence. Now keep in mind, as our main focus is on the major economies and the major central banks, there might be some similarities or differences between the major central banks and emerging market central banks and for more info you can just do a quick Google search and that should suffice.

So turning back to central bank independence, it basically means they should be able to make their own decisions without the influence or the interference from the local government.

Now even though this is true for most of the central banks there are many times when some might feel that the government has too much sway, too much influence and say in the country’s central bank which of course can be dangerous from a sentiment point of view.

Now apart from that it’s important to know that each of the major central banks has a specific mandate given to them so their sole purpose is to achieve those mandates by basically using the monetary policy tools at their disposal to try and get as close to those mandates as they can.

So coming back to independence, they should always aim to make decisions in order to achieve their mandate and not to please any type of policy from the government so even if the government might not agree with the choices they’re making, their main priority and concern should always be to achieve their mandates.

Now these mandates differ slightly with some having secondary mandates as well, for the most part, looking at the major central banks which includes the federal reserve, the ECB, the Bank of Canada, Bank of England, the Swiss National Bank, Bank of Japan, Reserve Bank of Australia, of New Zealand, all of them share a very similar mandate and that is that they all share price stability as the most important mandate that they need to adhere to.

Now to accomplish this, most of them will have a specific target for inflation. Now usually that is set for about 2% but some might have a target band of between let’s say 1% and 3% if we look at something like Australia and New Zealand.

Now the other mandates that most of them share apart from price stability is stable economic growth so they usually achieve this or try and achieve this by successfully looking at price stability so inflation, because stable inflation allows for a smooth and efficient economic performance, that is usually where the most of the focus will be, trying to get that inflation to their target.

So some of the major central banks will also sometimes have other mandates as we said, secondary mandates, this might include something like maximum employment, if we look at something like the Fed and the BOE while others will also have something like the integrity of the currency as a particular mandate if we’d look at something like the BOC for example, the Bank of Canada.

So central banks will always try to make policy changes that’ll allow them to reach their mandates that’s the most important point. Whether their policy actions achieve their mandates of course, is a never ending battle of observing, analyzing, forecasting and then of course acting where they feel they need to.

So that is just a quick run down for your question, hope that helps. Any other questions, don’t hesitate to let us know.




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