An Introduction on Central Banks

Submitted By: David Leja

It is often said that central bankers have more power than the President, King, Parliament or whatever nominal ruling body governs the state in question. They gain this distinction for the simply reason that they control the money supply.

Origins of central banking can trace back to at least the 11th century, when the Knights Templar used their enormous treasury to form the first truly international banking system. The Templars' credibility, and ability to protect depositors' funds, were such that they won the trust of monarchs across Europe. Crusade-bound nobles could deposit savings and withdraw funds at any branch in Europe through a checking system.

Central banking has evolved quite a bit in the thousand years since the Templars' heyday, but the overall design remains the same. Chief among the central banker's responsibilities is securing investor confidence. The US Federal Reserve, for instance, was created to rationalize the money supply after extreme deflationary recessions in the late 1800s, due to wild fluctuations in the price of gold. Ripples of panic would wipe out entire regions' banking industries as depositors withdrew funds, forcing banks to close, defaulting on their obligations to other banks and in turn forcing those banks to close. A lender of last resort, the "Fed," was created. The Fed's weathering of all the crises, recessions and panics of the 20th century has given it enormous credibility as a safe haven of capital from all over the world.

Central banks vary in the degree to which they are insulated from short-term political winds. In the US, the Fed is mandated by Congress to have as its goals "full employment," low inflation, and steady growth of GDP, although in practice the Fed is largely autonomous. The Federal Reserve has three instruments with which to influence the money supply: open market operations, discount lending, and reserve requirements. The most frequently used of the three are open market operations. The FOMC meets 8 times a year to discuss the direction of their future operations and their funds target rate. That number has historically been very important for everyone from billionaire bankers calculating costs of leverage to blue-collar workers worried about their mortgages.