Loading the player...

What is a 'Central Bank'

A central bank, or monetary authority, is a monopolized and often nationalized institution given privileged control over the production and distribution of money and credit. In modern economies, the central bank is responsible for the formulation of monetary policy and the regulation of member banks.

The central bank of the United States is the Federal Reserve System, or “the Fed,” which Congress established with the 1913 Federal Reserve Act.

BREAKING DOWN 'Central Bank'

Central banks are inherently non-market-based or even anticompetitive institutions. Many central banks, including the Fed, are often touted as independent or even private. However, even if a central bank is not legally owned by the government, its privileges are established and protected by law.

The critical feature of a central bank — distinguishing it from other banks — is legal monopoly privilege for the issuance of bank notes and cash; privately owned commercial banks are only permitted to issue demand liabilities, such as checking deposits.

Functions of Central Banks

The normative justification for central banking rests on three critical factors. First, the central bank manages the growth of national monetary aggregates in an attempt to guide economic policy, often with the aim of full employment. The bank also acts as an emergency lender to distressed commercial banks and other institutions. Finally, a central bank offers much greater financing flexibility the central government by providing a politically attractive alternative to taxation.

Central banks conduct standard monetary policy by manipulating the money supply and interest rates. They regulate member banks through capital requirements, reserve requirements and deposit guarantees, among other tools.

The first prototypes for modern central banking were the Bank of England and the Swedish Riksbank in the 17th century. The Bank of England was the first to acknowledge the role of lender of last resort. Other early central banks, notably Napoleon’s Bank of France and Germany's Reichsbank, were established to finance expensive government military operations.

Central Banking in the United States

It was principally because European central banks made it easier for governments to grow, wage war and enrich special interests that many of America's founding fathers, most passionately Thomas Jefferson, opposed central banking. Despite these objections, the early United States used both official central banks and numerous state-chartered banks, except for the “free-banking period” between 1837 and 1863.

The National Banking Act of 1863 created a network of national banks and a single U.S. currency, with New York as the central reserve city. The United States subsequently experienced a series of bank panics in 1873, 1884, 1893 and 1907. In response, the United States established the Federal Reserve System and spread 12 Federal Reserve Banks throughout the country to stabilize financial activity.

The new Fed helped finance World War I and World War II by purchasing Treasury bonds. Unfortunately, even more severe financial crises persisted in the Fed era, notably in 1929, 1937, 1980 and 2007. Despite the best efforts of the Federal Reserve and its board of governors, stable central bank policy remains elusive.

RELATED TERMS
  1. National Bank

    In the United States, a commercial bank chartered by the comptroller ...
  2. Bank

    A financial institution licensed as a receiver of deposits. There ...
  3. State Bank

    A financial institution that has been chartered by a state to ...
  4. Reserve Assets

    Currency, commodities or other financial capital held by monetary ...
  5. Federal Reserve Bank

    The central bank of the United States and the most powerful financial ...
  6. European Central Bank - ECB

    The central bank responsible for the monetary system of the European ...
Related Articles
  1. Personal Finance

    What Does a Central Bank Do?

    A central bank oversees a nation’s monetary system.
  2. Insights

    What Are Central Banks?

    They print money, they control inflation, and much, much more. All you need to know about central banks is here.
  3. Small Business

    Can Bitcoin Kill Central Banks?

    Bitcoin is a peer-to-peer unofficial currency that operates without government or central bank oversight. Can Bitcoin kill off the need for central banks?
  4. Insights

    How Central Banks Control The Supply Of Money

    A look at the ways central banks pump or drain money from the economy to keep it healthy.
  5. Investing

    Get To Know The Major Central Banks

    The policies of these banks affect the currency market like nothing else. See what makes them tick.
  6. Personal Finance

    What Is The Bank For International Settlements?

    Get the scoop on the structure and functions of the oldest global financial institution.
  7. Trading

    Explaining the Federal Reserve System

    The Federal Reserve System is the central bank of the United States. It regulates monetary policy and supervises the nation’s banking system.
  8. Insights

    What Do the Federal Reserve Banks Do?

    These 12 regional banks are involved with four general tasks: formulate monetary policy, supervise financial institutions, facilitate government policy and provide payment services.
  9. Insights

    A Brief History of U.S. Banking Regulation

    From the establishment of the First Bank of the United States to Dodd-Frank, American banking regulation has followed the path of a swinging pendulum.
  10. Insights

    Regional Banks Give The Fed A National Perspective

    We all know that the Federal Reserve utilizes monetary policy to control the economy, but what do the 12 regional Federal Reserve Banks do?
RELATED FAQS
  1. How do central bank decisions affect volatility?

    Using an aggregate, macroeconomic perspective, take a look at how some of the ways central bank decisions can impact market ... Read Answer >>
  2. How are bank reserve requirements determined and how does this affect shareholders?

    Learn how bank reserve requirements are determined and how bank reserves affect shareholders through improved bank stability ... Read Answer >>
  3. Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of interest ... Read Answer >>
  4. How do central banks acquire currency reserves and how much are they required to ...

    A currency reserve is a currency that is held in large amounts by governments and other institutions as part of their foreign ... Read Answer >>
  5. What economic indicators are important to consider when investing in the banking ...

    Find out which economic indicators are most useful for investors in the banking sector, especially those influenced by central ... Read Answer >>
  6. What do banks do to control the bank reserve?

    Understand what the Federal Reserve does in order to expand or contract the economy. Learn what depository institutions can ... Read Answer >>
Hot Definitions
  1. 403(b) Plan

    A retirement plan for certain employees of public schools, tax-exempt organizations and certain ministers. Generally, retirement ...
  2. Master Of Business Administration - MBA

    A graduate degree achieved at a university or college that provides theoretical and practical training to help graduates ...
  3. Liquidity Event

    An event that allows initial investors in a company to cash out some or all of their ownership shares and is considered an ...
  4. Job Market

    A market in which employers search for employees and employees search for jobs. The job market is not a physical place as ...
  5. Yuppie

    Yuppie is a slang term denoting the market segment of young urban professionals. A yuppie is often characterized by youth, ...
  6. SEC Form 13F

    A filing with the Securities and Exchange Commission (SEC), also known as the Information Required of Institutional Investment ...
Trading Center