What's the Point of a Central Bank?

What’s the Point of a Central Bank?

Central banks are a key part of public finance, as they manage money supply, currency and interest rates. In addition, particularly in United States, they oversee significant portions of the commercial banking system, upholding rules and regulations that help keep the nation economically stable. Central banks also hold much of the world’s gold reserves, with banks buying significant amounts during periods of low stability.

But are central banks really necessary? What do they actually do?

Coordinating Monetary Supply

In as far as monetary supply goes, central banks are vital. While individual banks could produce notes and currency, it puts them at risk for bankruptcy should they produce more than they can actually back. If such a bank falls due to a run (such as in the case of Northern Rock in the UK), the monetary supply becomes worthless.

A central bank, on the other hand, doesn’t primarily engage in commercial enterprise, instead focusing on the stability of the economy. Even central banks that engage in some limited commercial business are primarily focused on ensuring the liquidity of the money supply and keeping investors from suffering if a regional or national bank goes under. For this reason, central banks are sometimes described as the lender of last resort, as they generally have the largest reserves in the nation.

Promoting Economic Stability

The hyperinflation seen in Zimbabwe over recent years, and the hyperinflation seen in Hungary, Yugoslavia and Weimar, Germany, in the past was more or less caused by central banks producing notes that had no value. Essentially, credit was produced by printing notes, yet each note became progressively less valuable because the gold reserves backing it were not present.

Theoretically, central banks are less prone to this type of activity simply because their job is to ensure the stability of the nation and they are usually answerable to the government of that nation. Commercial banks, on the other hand, are seen as more likely to fall prey to such temptation. Without adequate gold reserves, they might force the expansion of credit without the necessary backup, resulting in excessive inflation. Some argue that this is a likely scenario, given the recent banking crisis and the events that led up to it.

Contributing to Financial Policy

Banking policy has been informed throughout the years by thousands of scholars, ranging from Adam Smith to John Maynard Keynes, and central banks still rely on some of these ideas as they contribute to national and global financial policy. Central banks help to set interest rates that benefit the nation as a whole to ensure that individuals are not unduly harmed by banking practices. In some cases, central banking policy is a reason that inflation remains relatively low despite economic recession. Central banks also encourage and employ researchers to watch for trends, gather information and drive economic activity to keep the country liquid.

Ultimately, regardless of policies, at the heart of the banking system lies gold. Gold-backed assets strengthen a nation just as gold can form a core part of individual portfolios. Make sure you are hedging your investments with gold to take full advantage of the stability and opportunities offered by precious metals.