History of Central Bank

A central bank, reserve bank, or monetary authority is an institution that regulates a state’s commercial banking system and manages the currency and monetary policy of that state or formal monetary union. A central bank, unlike a commercial bank, has a monopoly on growing the monetary base. Most central banks have supervisory and regulatory powers to maintain the stability of member institutions, prevent bank runs, and prohibit member banks from engaging in irresponsible or fraudulent activities.

Most developed countries’ central banks are institutionally free of political meddling. Even yet, the executive and legislative branches have limited control.

Early history

Money has always been used as a unit of account. The ancient Egyptian economy (2750–2150 BCE) shows evidence of government control of money. The Egyptians used a central unit called shat to calculate the worth of commodities. The shat, like many other currencies, was linked to gold. Government administrations determined the worth of a shat in terms of products. Other cultures in Asia Minor later developed gold and silver coins as a kind of currency.

A network of professional banks was created in Southern and Central Europe during the medieval and early modern periods. In the financial economy, the institutes created a new tier. Government institutions continued to exert influence over the monetary system, primarily through the coinage prerogative. Banks, on the other hand, might create deposits for their customers using book money. As a result, they were able to issue, lend, and move money independently of government oversight.

At the beginning of the 17th century, a network of public exchange banks was established in major European trading centres to help strengthen the monetary system. In 1609, the Amsterdam Wisselbank became the first institute in the city. Hamburg, Venice, and Nuremberg all had their own exchange banks. The institutes provided a public infrastructure for making international payments without using currency. They attempted to boost international trade efficiency and maintain monetary stability. As a result, the exchange banks performed similar functions to modern central banks. The institutes even created Mark Banco, their own (book) money.

Monetary policy

At its most basic level, monetary policy entails determining whether a country’s currency is a fiat currency, a gold-backed currency (which is prohibited by the International Monetary Fund), a currency board, or a currency union. When a country has its own national currency, it must issue standardised currency, which is simply a promissory note that can be used as “money” in specific conditions. This was traditionally a pledge to exchange money for precious metals in a specific amount. Now that many currencies are fiat money, the “promise to pay” is just a commitment to accept that currency and pay taxes in that currency.

Goals of central bank

Price stability

The fundamental function of central banks is to preserve price stability, which is defined as an inflation rate that does not exceed a certain threshold. Inflation is defined as the depreciation of a currency or, in other words, the increase in prices relative to that currency. Inflation is currently being targeted by most central banks at around 2%.

Keynesians see inflation as a solution to involuntary unemployment since it lowers real wages. Inflation that is “unexpected” causes lenders to lose money since the real interest rate is lower than expected. As a result, Keynesian monetary policy seeks to maintain a constant rate of inflation. The Case Against the Fed, a pamphlet from the Austrian School, claims that central banks’ efforts to control inflation have been fruitless.

High employment

The time between jobs while a worker is looking for work or migrating from one job to another is known as frictional unemployment. Unintended unemployment is defined as unemployment that is not caused by friction.

Structural unemployment, for example, is a type of unemployment caused by a mismatch between labour market demand and the skills and locations of employees looking for work. The goal of macroeconomic policy is to eliminate unplanned unemployment.

Economic growth

Capital investment, such as more or better machinery, can help boost economic growth. With a low interest rate, businesses can borrow money to invest in their capital stock while paying less interest. Lowering interest rates is thus thought to promote economic growth and is frequently employed to ameliorate periods of sluggish growth. Raising the interest rate, on the other hand, is frequently employed as a counter-cyclical strategy to keep the economy from overheating and avoid market bubbles during periods of rapid economic growth.

Stability of interest rates, the financial market, and the foreign currency market are other monetary policy objectives. Goals frequently can’t be isolated from one another, and they usually clash. As a result, before implementing a policy, costs must be carefully considered.

Conclusion

The first prototype banks were the world’s merchants, who provided grain loans to farmers and traders who transported products between towns. A central bank, unlike a commercial bank, has a monopoly on growing the monetary base. Most central banks have supervisory and regulatory powers to maintain the stability of member institutions, prevent bank runs, and prohibit member banks from engaging in irresponsible or fraudulent activities. Money has always been used as a unit of account. The ancient Egyptian economy (2750–2150 BCE) shows evidence of government control of money.

A network of professional banks was created in Southern and Central Europe during the medieval and early modern periods. 

Government institutions continued to exert influence over the monetary system, primarily through the coinage prerogative. Banks, on the other hand, might create deposits for their customers using book money. 

The fundamental function of central banks is to preserve price stability, which is defined as an inflation rate that does not exceed a certain threshold. Capital investment, such as more or better machinery, can help boost economic growth. With a low interest rate, businesses can borrow money to invest in their capital stock while paying less interest.