H.S.S.A.

E
Second year Economic English

The central Bank: Position and Functions

The Central Bank is a natural outcome of the evolutionary process which led to the structuring of the
Banking system as it is known nowadays.

 At first, central banks were private profit-making institutions, (and up to now the Fed - the US
central bank- is a private institution) providing services as ordinary banks. But their potential
to influence the behavior of the other commercial banks and through them the behavior of the
whole economy led to the development of close ties with governments. In most European
countries, these ties eventually became formalized as the central banks were taken over by
governments.

The central bank is always an instrument of the central authorities, whether or not it is owned
publicly, and it is the agent of the government monetary policy. In general, the central bank has
many functions within the banking system:

1. It is the banker to the government:

Governments need to hold their funds in an account into which they can make deposits and
against which they can draw cheques. Such deposits are usually held by the central bank.

2. The manager of the public debt:

The central bank helps the government with its debt requirements: as any other agent in the
economy, the government needs money to finance its various operations, and the central bank
manages its borrowing and lending requirements in such a way that they do not affect badly
the economy. In its capacity as a manager of the public debt, the central bank is motivated to
keep interest rates and thus the government’s interest payments as low as possible.

3. The central bank is the banker to the commercial banks:

Since the commercial banks need themselves a place where to deposit their funds, they need
someone who can lend them money when they are short of cash: they require thus a banker!
By accepting deposits from commercial banks, transferring these deposits among them and
lending them cash at interest, the central bank acts as the banker to the banking system

4. The lender of last resort:

When the banks of second rank (commercial) are short of cash, they can turn to the central
bank which provides them with money but at a penal rate.

5. The central bank supports the money market:

This support function of the central bank stems from its operation as a lender of last resort to
the financing system. To prevent interest rates from increasing, the central bank enters the
money market and buys bonds, injecting thus money in the economy. This has as result of
varying the money supply.
6. The regulator of the money supply:
In most countries, the central bank is the one to have the power to issue paper money.
Therefore, it can exert a control over the money supply and regulate the amount of money in
circulation in the economy.
Through these various prerogatives, the central bank performs the monetary policy of the
central authorities, and with regard to the prevailing situation of the economy, certain of its
functions are favoured instead of others.

Comprehension
1. What was the bank originally?
2. How did central banks ties with governments come to be?
3. In what kind of action the central bank is used by the government?
4. What are the different accounts the government may have at the central banks?
5. How can government’s operations affect badly the economy?
6. Can the commercial banks operate without the central bank?
7. What kind of services does the central bank provide to the commercial banks?
8. Why is the central bank called “lender of last resort”?
9. Is the central bank the only institution that can create money? Whatever is your answer,
explain!

Exercise

1. The banking system has evolved to the structure it is known at present

True False

2. The central bank has always been a public institution

True False

3. The central bank influences directly the behavior of the whole economy
True False

4. The central bank has at its disposal the government’s funds

True False

5. The government always turns to the central bank whenever it needs cash
True False

6. The government’s operations have no effect on the money supply

True False
7. The primary banks borrow from the central bank at a cost
True False

8. Money supply and interest rates depend on each other

True False

9. The monetary policy is performed by the banking system

True False

10. The central bank cannot control the money supply

True False