Money & Banking
Microeconomic Decision Makers
A central bank is the bank, usually owned by the government, that issues the currency and operates monetary policy (for example, setting the main interest rate) and acts as banker to the government and to the . There is normally only one in each country.
The central bank carries out roles that no commercial bank performs.
| Role | What the central bank does |
|---|---|
| Issuing currency | It is responsible for printing notes and minting coins, controlling the money supply. |
| Operating monetary policy | It sets the country's main interest rate to influence borrowing, spending and inflation. |
| Banker to the government | It holds the government's accounts and helps manage government borrowing. |
| Banker to the commercial banks | It holds banks' reserves and acts as lender of last resort, lending to banks in difficulty to keep the financial system stable. |
| Regulating the banking industry | It supervises commercial banks and sets the rules they must follow, protecting depositors and keeping the financial system sound. |
| Managing the exchange rate and reserves | It holds the country's foreign-currency reserves and may buy or sell currency. |
Common exam question
Telling a central bank's role from a commercial bank's
Question: Choose the function or role that belongs to a central bank, or to a commercial bank, from options that mix the two (1 mark, multiple choice); or define a central bank (2 marks).
Set in 7 of the 13 multiple-choice papers. Asked in 1 of the 11 structured papers. Sort each option by whom the bank serves. The central bank is the government's bank and the banks' bank: it issues notes and coins, runs monetary policy aiming at stable prices, controls the banking system and is lender of last resort to a bank facing a liquidity crisis (short of cash, not merely unprofitable). A commercial bank is owned by shareholders and serves households and firms: deposits, savings accounts, loans, mortgages, credit cards. Setting the government's budget is neither bank's job.
For the definition, any two of three ideas score: government-owned; operates monetary policy (setting interest rates, managing the exchange rate); banker to the government or to the commercial banks.