What Is a Central Bank?

Every nation or region has a central body that is responsible to oversee its economic and monetary policies and to ensure the financial system remains stable. This body is called the central bank. Unlike commercial and investment banks, these institutions aren't market-based and they are not competitive.

Many central banks are concerned with inflation, which is the movement of prices for goods and services. They keep inflation in line with interest rates. For instance, a central bank will increase interest rates when inflation exceeds its target in order to slow growth. Conversely, it lowers interest rates when inflation drops below the bank's target to spur growth.

The majority of the world's central banks are independent and answer to their federal governments and, therefore, the general population. This article looks at several of the world's most influential central banks, their mandates, and their structures.

Key Takeaways

  • Central banks are responsible for economic and monetary policy and they make sure the soundness of the financial system.
  • These institutions set interest rates and control the money supply of a country.
  • The U.S. Federal Reserve is one of the most powerful central banks in the world.
  • The European Central Bank oversees the policies of the eurozone.
  • Other notable central banks include the Bank of England, the Bank of Japan, the Swiss National Bank, the Bank of Canada, and the Reserve Banks of Australia and New Zealand.

U.S. Federal Reserve System (Fed)

The Federal Reserve, commonly referred to as the Fed, is the central bank of the United States. It is probably the most influential central bank in the world. With the U.S. dollar used for approximately 90% of all of the world's currency transactions, the Fed's sway has a sweeping effect on the valuation of many currencies.

The Fed is responsible to ensure the U.S. economy operates effectively while keeping the best interests of the public in mind. It does this by performing five key functions that promote monetary policy, financial stability, the soundness of individual financial institutions, the safety of payment and settlement systems, and consumer protection.

The Fed is made up of three distinct groups:

  • The Board of Governors: This group works independently of the U.S. government but reports directly to Congress, which oversees the Federal Reserve. The seven governors or board members are nominated by the U.S. president and confirmed by the U.S. Senate. The board is responsible for maintaining the Fed's goals. Each board member serves on the Federal Open Market Committee (FOMC).
  • The Federal Reserve Banks: This group is made up of 12 regional banks that oversee various parts of the country. These are located in Boston, New York, Philadelphia, Cleveland, Richmond, Atlanta, Chicago, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco. The banks are supervised by the Fed's board.
  • The Federal Open Market Committee: This group is also called the FOMC and is made up of the board members, the 12 presidents of the reserve banks. The chair of the FOMC is the head of the Federal Reserve Board. The FOMC meets eight times a year, when it goes over economic conditions, the stability of the financial system, and monetary policy.

European Central Bank (ECB)

The European Central Bank (ECB) was established in 1999. The governing council of the ECB is the group that decides on changes to monetary policy. The council consists of six members of the executive board of the ECB, plus the governors of all the national central banks from the 19 eurozone countries.

As a central bank, the ECB does not like surprises. Whenever it plans to change interest rates, it generally gives the market ample notice by warning of an impending move through comments to the press.

The bank's mandate is to keep prices stable and ensure that growth is sustainable. Unlike the Fed, the ECB strives to maintain the annual growth in consumer prices below 2%. As an export-dependent economy, the ECB also has a vested interest in preventing excess strength in its currency because this poses a risk to its export market.

The ECB's council meets bi-weekly, but policy decisions are generally made at meetings where there is an accompanying press conference. These meetings happen 11 times a year.

Bank of England (BOE)

The Bank of England (BOE) is publicly-owned, which means it reports to the British people through parliament. Founded in 1694, it is often touted as one of the world's most effective central banks. Its mission is to maintain stability in its monetary and financial systems. To accomplish this, the central bank has an inflation target of 2%. If prices surpass that level, the central bank will look to curb inflation, while a level far below 2% will prompt the central bank to take measures to boost inflation.

The BOE also ensures:

  • the soundness of the nation's financial institutions
  • the security of its currency
  • its financial system is free from unnecessary risk

The bank's monetary policy committee is a nine-member committee that consists of a governor, three deputy governors, a chief economist, and four outside experts. The bank's Monetary Policy Committee meets eight times a year to announce its policy.

Bank of Japan (BOJ)

The Bank of Japan (BOJ) began operating in 1882. Its mission is to maintain price stability and to ensure the stability of the financial system. This makes inflation the central bank's top focus. Because Japan is very dependent on exports, the BOJ has an even more active interest than the ECB does in preventing an excessively strong currency.

The bank's monetary policy committee consists of the governor, two deputy governors, and six other members. The central bank has been known to come into the open market to artificially weaken its currency by selling it against U.S. dollars and euros. The BOJ is also extremely vocal when it feels concerned about excess currency volatility and strength. It meets eight times a year.

Swiss National Bank (SNB)

The Swiss National Bank is an independent bank that is responsible for the nation's monetary policy. Its main goal is to maintain the stability of prices while overseeing economic conditions in the country. There are two different offices—one in Berne and the other in Zurich.

Like Japan and the eurozone, Switzerland is also very export-dependent. This means that the SNB does not have an interest in seeing its currency become too strong. Therefore, its general bias is to be more conservative with rate hikes.

The bank has a three-person committee that makes decisions on interest rates. Unlike most other central banks, the SNB determines the interest rate band rather than a specific target rate. The bank's committee meets quarterly to ensure the bank is meeting its mandate

Central banks answer to and act as lenders to their nations' governments.

Bank of Canada (BOC)

Canada's central bank is called the Bank of Canada. Its mandate is to ensure stability in Canada's economy and financial system. It accomplishes this by:

  • enacting monetary policy
  • overseeing the financial system
  • maintaining the value and supply of Canada's currency
  • managing public debt

The central bank has an inflation target of 1% to 3% with the aim of keeping it near 2%. It has done a good job of keeping inflation within that range since 1998.

Monetary policy decisions within the BOC are made by a consensus vote by the governing council, which consists of the bank's governor, the senior deputy governor, and four deputy governors. The executive council, which is made up of the governing council and the chief operating officer (COO), drafts the bank's strategic direction.

The Bank of Canada's council meets eight times a year.

Reserve Bank of Australia (RBA)

The Reserve Bank of Australia's functions are set out by the country's Reserve Bank Act 1959. The bank's mandate is to ensure its currency is stable, the maintenance of full employment, and the economic prosperity and welfare of the people of Australia.

The RBA's monetary policy committee consists of the central bank governor, the deputy governor, the secretary to the treasurer, and six independent members. These individuals are appointed by the federal government.

The central bank has an inflation target of 2 % to 3% per year. The committee meets 11 times a year, usually on the first Tuesday of each month, except in January.

Reserve Bank of New Zealand (RBNZ)

New Zealand's economy and monetary policy are overseen by the Reserve Bank of New Zealand (RBNZ). The bank is also responsible for sustainable levels of employment along with promoting a sound financial system.

The RBNZ has an inflation target range of 1% to 3%, which has been in place since 2000. But it focuses on a target of 1.5% in the medium term, which it announced at the end of 2018. Failure to meet this mid-term target could result in the dismissal of the RBNZ's governor.

Unlike other central banks, the decision-making power on monetary policy ultimately rests with the central bank governor. The bank's committee meets eight times a year.

The Bottom Line

The list above represents some of the most powerful central banks in the world. Although they may have different targets, structures, and meeting timelines, their mandates are generally the same. That is to ensure the economic prosperity of their nations, to oversee the financial system, and to control their currencies. These banks often work together to ensure that the global economy remains in check.