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Posted by on Aug 11, 2016 in Central Bank, Finance, Prices Stability, Uncategorized |

Understanding the role of a central bank

Understanding the role of a central bank

    Many people don’t understand the role a central bank has in a country. And due to that, they don’t realize the extent of the influence over the currency markets that this bank has. To understand its role we have to start from the beginning and explain primary duties this monetary authority possesses.

   A central bank has power over the amount and the strength of the state’s currency as well as interest rates within the country. They also have a duty to oversee the commercial system of banking in their respective country. This entity has full monopoly over the monetary base in a country, which means that they can print money whenever the need arises. To find more information check Wikipedia.

    The most fundamental and the imperative duty of this entity are to control the monetary policy of the country. One way to do this is through money printing. Other instruments that the bank uses include management of interest rates, lending to the banking sector, setting the reserve requirement and so on. Another important duty of a central bank is the supervision of the banking system within the country. They employ instruments that reduce the risk of reckless and fraudulent behavior in this sector.

    The stable monetary policy creates a strong currency. Stable currency leads to several changes in the country, and those changes are the goals of the central bank. Some of the most important aims that this monetary authority strives for include:

–    The stability of the prices through the controlled inflation is one of those goals. As you know, a high inflation reduces the value of the currency and increases the prices of the goods. Small inflation is useful for reducing the interest rate, which is also a bad for a country. A central bank tries to keep the inflation on a slow and steady increase. In this way, the economy can grow along with it.

–    High employment is a reflection of a robust and stable economy. Central bank aims to increase the rate of employment with several instruments, all depending on the type of the unemployment in the state. Three distinct types of unemployment exist (as measured by this monetary authority). First, there is the frictional unemployment which represents the period in which the worker’s transition between the jobs. Unintentional unemployment is the worst form of the unemployment. It happens when there is a lack of job positions on all levels. Structural unemployment occurs when there is demand for one type of workers, while those that have different skills have no job.

–    Economic growth is also an important goal of the central bank. To encourage economic growth this monetary authority lowers the interest rate. When a country goes through high economic growth, this entity will raise the interest rate to avoid market bubbles. The low-interest rate is good for economic growth, but it is devastating for the financial world and vice versa. A central bank has to shift their monetary policy to accommodate both sides, but it also needs to be careful not to damage either of those two.