Role of central banks

Central banks - key terms

Central banks - key terms

Central bank	The monetary authority and major regulatory bank in a country. Its functions include issuing and managing the country's currency
Central bank intervention	When a central bank enters the foreign exchange market to buy or sell currency in order to influence exchange rates
Base rate	The rate of interest set by the Bank of England, being in effect the lowest rate that lenders will charge interest at.
Basis point	One hundred basis points make up a percentage point, so an interest rate cut of 25 basis points might take the rate from 0.5% to 0.25%
Inflation target	The target set for the annual rate of consumer price inflation – for the UK the target is CPI inflation of 2%
Base Money	Currency (banknotes and coins) in circulation plus minimum reserves credit institutions are required/choose to hold with the central bank
Bond Market	The market for interest-bearing securities (with either a fixed or a floating rate and with a maturity of at least one year) that companies and governments issue to raise capital for investment.
Financial stability	The condition in which the financial system – comprising financial intermediaries, markets and market infrastructures – is capable of withstanding shocks and the unravelling of financial imbalances Read more

Central banks

Main functions of a central bank

1. Monetary policy function
   1. Setting of the main monetary policy interest rate
   1. Quantitative easing
   1. Exchange rate intervention (managed/fixed currency systems)
2. Financial stability & regulatory function
   1. Supervision of the wider financial system
   1. Prudential policies designed to maintain financial stability
3. Policy operation functions
   1. Lender of last resort to the banking system
   1. Managing liquidity in the commercial banking system
4. Financial infrastructure provision function
   1. Overseeing the payments systems used by banks / retailers / credit card companies
   1. Debt management
   1. Handling the issue and redemption of issues of government debt

Current objectives of UK monetary policy

Monetary stability means stable prices and confidence in the currency. Stable prices are defined by the Government's inflation target, which the Bank seeks to meet through the decisions taken by the Monetary Policy Committee (MPC).

The Bank of England has been independent of the UK government since May 1997. The current governor is Mark Carney.

An Era of Extraordinary Monetary Policy

Central Banks of many advanced countries have made extraordinary sustained use of expansionary monetary policy in recent years:

Policy interest rates approaching the zero bound and remaining there (e.g. 0.5% in the UK and in the USA)

Negative policy rates in some countries (e.g. Japan, Sweden, Denmark and Switzerland)

Huge rise in the scale of quantitative easing (QE) designed to increase the base supply of money

Increasing use of exchange rate (currency) intervention as an instrument of monetary policy (i.e. a move towards managed floating)

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