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What is a Central Bank and How Does One Work?

A Central Bank is a financial institution given privileged control by the government over the production and distribution of money and credit for a nation or group of nations.


Most central banks are not government agencies. They are private organizations that are in charge of monetary policy for the nation from which the government borrows money.


The unique feature of a Central Bank is its monopoly on the creation and issuance of banknotes and cash. They control the money supply.


Central banks wield a couple of monetary powers that allow them to manipulate the economy of the nation over which they preside. The first power is the ability to raise or lower interest rates on the borrowing of the nation's currency.


Low interest rates promote economic growth because the cost of money is cheap, allowing for businesses and entrepreneurs to borrow money and grow the economy with low interest payments.


High interests rates slow economic growth. Businesses, entrepreneurs, and individuals in general cannot borrow as much. Money becomes more valuable as a result.


The second power that central banks wield is the ability to regulate other banks with capital requirements and reserve requirements; that is, how much liquid cash banks must have on hand, thus affecting how much banks can lend out to customers.



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