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Public finance

Sources ofgovernment revenue

Tax and non-tax revenue

Government policy

FiscalMonetaryTradePolicy mix

Fiscal policy

Tax policy (see taxation series)Government revenueGovernment debtGovernment spending (Deficit spending)

Budget deficit and surplus

Monetary policy

Money supplyCentral bankGold standardFiat currency

Trade policy

Balance of tradeTariffTariff war

Free tradeTrade pact

See also

Taxation seriesProject Thisbox:viewtalkedit

Acentral bank, reserve bank, ormonetary authority is a public institution that usually issues the

currency, regulates the money supply, and controls the interest rates in a country. Central banks often also

oversee the commercial banking system within its country's borders. A central bank is distinguished from a


2/17

normal

ommercial

ank

ecause it asamonopol oncreating t ecurrencyof t at nation,

ich isusually

that nation'slegal tender.[1][2]

Theprimary functionofacentral

ank is toprovide thenation'smoneysupply,

ut moreactiveduties

includecontrollinginterest rates, andactingasalenderof last resort to the

ankingsectorduring timesof

financial crisis. Itmayalsohavesupervisorypowers, toensure that

anksandotherfinancial institutionsdo

not

ehaverecklesslyorfraudulently.

Most developednations todayhavean "independent" central

ank, that isonewhichoperatesunderrules

designed toprevent political interference. Examples include theEuropean entral Bank (E B) and

theederal Reserve System in the United States.[3]

Contents

[hi

]

1 Hi t

2 Acti iti and responsi

ilities

o 2.1Monetary policy

3 Goals of monetary policy

o 3.1 Currency issuance

o 3.2 Naming of central banks

o 3.3 Interest rate interventions

o 3.4 Limits of enforcement power

4 Policy instruments

o 4.1 Interest rates

o 4.2 Open market operations

o 4.3 Capital requirements

o 4.4 Reserve requirements

o 4.5 Exchange requirements

o 4.6Margin requirements and othertools

4.6.1 Examples of use

5Banking supervision and other activities

6 Independence

7 Criticism

o 7.1 Alternatives

8 See also

9 References

10 Externallinks

[edit]History


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he Bank of England, established in

694.

In Europe prior to the7th century most money was commodity money, typically gold or silver.

owever,

promises to pay were widely circulated and accepted as value at least five hundred years earlier in both

Europe and Asia.!

he Song Dynasty was the first to issue generally circulating paper currency, while

the Yuan Dynasty was the first to use notes as the predominant circulating medium. In455, in an effort to

control inflation, the succeeding"

ing Dynasty ended the use of paper money and closed much of Chinese

trade.!

he medieval European Knights!

emplarran an early prototype of a central banking system, as their

promises to pay were widely respected, and many regard their activities as having laid the basis for the

modern banking system.

As the first public bank to#offer accounts not directly convertible to coin

#, theBank of

Amsterdam established in609 is considered to be a precursor to a central bank. [4] In

664, the central

bank of Sweden#

Sveriges$

iksbank#

or simply# $

iksbanken#

was founded in Stockholm and is by that

the world's oldest central bank%

still operating today&

.[5]!

his was followed in

694 by the Bank of England,

created by Scottish businessmanWilliam Paterson in the City of London at the request of

the English government to help pay for a war.

Although central banks today are generally associated withfiat money, the nineteenth and early twentieth

centuries central banks in most of Europe andJapan developed under the international gold standard,

elsewhere free banking orcurrency boards were more usual at this time. Problems with collapses of banks

during downturns, however, was leading to wider support for central banks in those nations which did not as

yet possess them, most notably in Australia.

With the collapse of the gold standard afterWorld War I, central banks became much more widespread.!

he'

S Federal$

eserve was created by the'

.S. Congress through the passing of the Glass-Owen Bill,

signed by President Woodrow Wilson on December( )

,

9 )

, whilst Australia established its first central

bank in9

(0, Colombia in

9

( ),

"e

0

ico and Chile in9

(5 and Canada and New Zealand in the aftermath

of the Great Depression in

9)

4. By

9)

5, the only significant independent nation that did not possess a

central bank was Brazil, which developed a precursor thereto in945 and created its present central bank

twenty years later. When African and Asian countries gained independence, all of them rapidly established

central banks or monetary unions.


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The People's Bank of China evolved its role as a central bank starting in about1979 with the introduction of

market reforms in that country, and this accelerated in1989 when the country took a generally capitalist

approach to developing at least its e2

port economy. By3000 the People's Bank of China was in all senses

a modern central bank, and emerged as such partly in response to theEuropean Central Bank. This is the

most modern bank model and was introduced with the euro to coordinate the European national banks,

which continue to separately manage their respective economies other than currency e2

change and base

interest rates.

[edit]Activities and responsibilities

4nited StatesFederal

5eserve

Functions of a central bank may include:

implementing monetary policy

determining Interest rates

controlling the nation's entire money supply

the Government's banker and the bankers' bank 6 7 lender of last resort 7 8

managing the country's foreign e2 change and gold reserves and the Government's stock register

regulating and supervising the banking industry

setting the official interest rate used to manage both inflation and the country's e2 change rate and

ensuring that this rate takes effect via a variety of policy mechanisms

[edit]Monetary policy

Central banks implement a country's chosen monetary policy. At the most basic level, this involves

establishing what form of currency the country may have, whether a fiat currency, gold-backed

currency9disallowed for countries with membership of the I

@F

A, currency board or a currency union. When

a country has its own national currency, this involves the issue of some form of standardized currency,which is essentially a form ofpromissory note: a promise to e

B

change the note forCmoney

Cunder certain

circumstances.D

istorically, this was often a promise to eB

change the money for precious metals in some

fiB

ed amount. Now, when many currencies are fiat money, theCpromise to pay

Cconsists of nothing more

than a promise to pay the same sum in the same currency.

In many countries, the central bank may use another country's currency either directly9in a currency union

A,

or indirectly, by using a currency board. In the latter case, local currency is directly backed by the central


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bank's holdings of a foreign currency in a fiE

ed-ratio; this mechanism is used, notably, in Bulgaria,F

ong

Kong and Estonia.

In countries with fiat money, monetary policy may be used as a shorthand form for the interest rate targets

and other active measures undertaken by the monetary authority.

[edit]Goals of monetary policy

The ECBbuilding in Frankfurt

Price Stability

Gnanticipated inflation leads to lender losses. Nominal contracts attempt to account for inflation.

Effort successful if monetary policy able to maintain steady rate of inflation.

High Employment

The movement of workers between jobs is referred to as frictional unemployment. All

unemployment beyond frictional unemployment is classified as un intended unemployment.

H eduction in this area is the target of macroeconomic policy.

Economic Growth

Economic growth is enhanced by investment in technological advances inproduction.

Encouragement of savings supplies funds that can be drawn upon for investment.

Interest Rate Stability

Volatile interest and eE change rates generate costs to lenders and borrowers.G

neE pected

changes that cause damage, making policy formulation difficult.

Financial Market Stability

Foreign Exchange Market Stability

Conflicts Among Goals


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Goals frequentlycannot I eseparated fromeachotherandoftenconflict. P ostsmust therefore I e

carefullyweighed I eforepolicy implementation.

[edit]Currency i uance

Manycentral I anksare " I anks" in thesense that theyholdassets (foreign

exchange, gold, andotherfinancial assets)and liabilities. Acentral bank's

primary liabilitiesare thecurrencyoutstanding, and these liabilitiesarebacked

by theassets thebankowns.

P entral banksgenerallyearnmoneyby issuingcurrencynotesand "selling"

them to thepublic for interestQbearingassets, suchasgovernment bonds.

Sincecurrencyusuallypaysno interest, thedifference in interest generates

income, calledseigniorage. Inmost central bankingsystems, this income is

remitted to thegovernment. The European P entral Bankremits its interest

income to itsowners, thecentral banksof themembercountriesof the

European Union.

Althoughcentral banksgenerallyholdgovernment debt, insomecountries the

outstandingamount ofgovernment debt issmallerthan theamount thecentral

bankmaywish tohold. Inmanycountries, central banksmayholdsignificant

amountsof foreigncurrencyassets, ratherthanassets in theirownnational

currency, particularlywhen thenational currency is fixed toothercurrencies.

[edit]Naming central anks

There isnostandard terminology forthenameofacentralbank, but many

countriesuse the "Bankof P ountry" form (e.g., Bankof England, Bankof

P anada, Bankof Russia). Somearestyled "national" banks, suchas

the R ational Bankof Ukraine; but the term "national bank" ismoreoftenused

byprivately-ownedcommercial banks, especially in theUnited States. Inother

cases, central banksmay incorporate theword " P entral" (e.g. European

P entral Bank, P entral Bankof Ireland). Theword "Reserve" isalsooften

included, suchas theReserve Bankof India, Reserve Bankof

Australia, Reserve BankofR ew S ealand, theSouthAfrican Reserve Bank, and

U.S.T ederal ReserveSystem. Manycountrieshavestate-ownedbanksor

otherquasi-government entities that haveentirelyseparate functions, suchas

financing importsandexports.

Insomecountries, particularly insome P ommunist countries, the termnational

bankmaybeused to indicateboth themonetaryauthorityand the leading

bankingentity, suchas theUSSR'sGosbank(statebank). Inothercountries,

the termnational bankmaybeused to indicate that thecentral bank'sgoals


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arebroader thanmonetarystability, suchas full employment, industrial

development, orothergoals.

[edit]Interestrate interventi ns

Typicallyacentral bankcontrolscertain typesofshort-terminterest rates.

These influence thestock-andbondmarketsaswell asmortgageandother

interest rates. TheEuropeanUentral Bank forexampleannounces its interest

rateat themeetingof itsGoverningUouncil; in thecaseof the

Vederal

Reserve, theBoardofGovernors.

Both the V ederal Reserveand the E U B arecomposedofoneormorecentral

bodies that areresponsible forthemaindecisionsabout interest ratesand the

siWeand typeofopenmarket operations, andseveral branches toexecute its

policies. In thecaseof the V ed, theyare the local V ederal Reserve Banks; for

the E U B theyare thenational central banks.

[edit]Limits enforcement ower

U ontrary topopularperception, central banksarenot all-powerful andhave

limitedpowers toput theirpolicies intoeffect. Most importantly, although the

perceptionby thepublicmaybe that the "central bank" controlssomeorall

interest ratesandcurrencyrates, economic theory (andsubstantial empirical

evidence) shows that it is impossible todobothat once inanopen

economy. Robert Mundell's "impossible trinity" is themost famous formulation

of these limitedpowers, andpostulates that it is impossible to target monetary

policy (broadly, interest rates), theexchangerate (througha fixedrate) and

maintain freecapital movement. SincemostX

esterneconomiesarenow

considered "open" with freecapital movement, thisessentiallymeans that

central banksmay target interest ratesorexchangerateswithcredibility, but

not bothat once.

Evenwhen targeting interest rates, most central bankshave limitedability to

influence theratesactuallypaidbyprivate individualsandcompanies. In the

most famouscaseofpolicy failure,George Sorosarbitraged thepound

sterling'srelationship to theE U Uand (aftermaking $2 billionhimselfand

forcing the UK tospendover$ Y bndefending thepound) forced it toabandon

itspolicy. Since thenhehasbeenaharshcriticofclumsybankpoliciesand

argued that nooneshouldbeable todowhat hedid.

Themost complex relationshipsare thosebetween theyuanand theUS dollar,

andbetween theeuroand itsneighbours. Thesituation in U uba isso

exceptional as torequire the U ubanpeso tobedealt withsimplyasan


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exception, since the United States forbidsdirect tradewith uba. US dollars

wereubiquitous in uba'seconomyafterits legali a ation in 1 b b 1, but were

officiallyremoved fromcirculation in 2 c cd

andreplacedby theconvertible

peso.

[edit]Policy instruments

Themainmonetarypolicy instrumentsavailable tocentral banksareopen

market operation, bankreserverequirement, interest ratepolicy, re-lendingand

re-discount (includingusing thetermrepurchasemarket), andcredit

policy (oftencoordinatedwithtradepolicy).e

hilecapital adequacy is

important, it isdefinedandregulatedby theBank forInternational Settlements,

andcentral banks inpracticegenerallydonot applystricterrules.

Toenableopenmarket operations, acentral bankmust holdforeignexchange

reserves (usually in the formofgovernment bonds) andofficial goldreserves. Itwill oftenhavesome influenceoveranyofficial ormandatedexchangerates:

Someexchangeratesaremanaged, somearemarket based (free float) and

manyaresomewhere inbetween ("managed float" or"dirty float").

[edit]Interestrates

By farthemost visibleandobviouspowerofmanymoderncentral banks is to

influencemarket interest rates; contrary topopularbelief, theyrarely "set" rates

toa fixednumber. Although themechanismdiffers fromcountry tocountry,

most useasimilarmechanismbasedonacentral bank'sability tocreateas

muchfiat moneyasrequired.

Themechanism tomove themarket towardsa'target rate' (whicheverspecific

rate isused) isgenerally to lendmoneyorborrowmoney in theoretically

unlimitedquantities, until the targetedmarket rate issufficientlyclose to the

target. entral banksmaydosoby lendingmoney toandborrowingmoney

from (takingdeposits from) a limitednumberofqualifiedbanks, orby

purchasingandsellingbonds. Asanexampleofhow this functions, theBankof

anadasetsa target overnight rate, andabandofplusorminus c .2f %.

Qualifiedbanksborrow fromeachotherwithin thisband, but neveraboveorbelow, because thecentral bankwill always lend to themat the topof the

band, and takedepositsat thebottomof theband; inprinciple, thecapacity to

borrowand lendat theextremesof thebandareunlimited.[ g ] h thercentral

banksusesimilarmechanisms.

It isalsonotable that the target ratesaregenerallyshort-termrates. Theactual

rate that borrowersand lendersreceiveon themarket will dependon


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(perceived) credit risk, maturityandotherfactors. i orexample, acentral bank

might set a target rate forovernight lendingofp

.q%, but rates for(equivalent

risk) five-yearbondsmight be q %,p

. r q %, or, incasesofinvertedyieldcurves,

evenbelow theshort-termrate. Manycentral bankshaveoneprimary

"headline" rate that isquotedas the "central bankrate." Inpractice, theywill

haveothertoolsandrates that areused, but onlyone that isrigorously

targetedandenforced.

"Therateat which thecentral bank lendsmoneycan indeedbechosenat will

by thecentral bank; this is therate that makes the financial headlines."- Henry

s.K.

tiu.[ u ] t iuexplains furtherthat "the U.S. central-bank lendingrate isknown

as theied fundsrate. The

iedsetsa target forthe

ied fundsrate, which

its v penMarket s ommittee tries tomatchby lendingorborrowing in

themoneymarket ... a fiat moneysystemset bycommandof thecentral bank.

The i ed is theheadof thecentral-bankbecause the U.S. dollaris thekey

reservecurrency forinternational trade. Theglobal moneymarket isa USA

dollarmarket. All othercurrenciesmarketsrevolvearound the U.S. dollar

market." Accordingly the U.S. situation isnot typical ofcentral banks ingeneral.

A typical central bankhasseveral interest ratesormonetarypolicy tools it can

set to influencemarkets.

Marginal lendingrate (currently 1.r q % in the Eurozone) w a fixedrate for

institutions toborrowmoney from thecentral bank. (In the USA this is

called thediscount rate).

Mainrefinancingrate (1.x x % in the Eurozone) w thepubliclyvisible interest

rate thecentral bankannounces. It isalsoknownasminimum bid rateand

servesasabidding floorforrefinancing loans. (In the USA this iscalled

thefederal fundsrate).

y eposit rate ( .2 % in the Eurozone) theratepartiesreceive fordeposits

at thecentral bank.

Theseratesdirectlyaffect therates in themoneymarket, themarket forshort

term loans.

[edit]Open marketoperations

Throughopenmarket operations, acentral bank influences themoneysupply

inaneconomydirectly. Each time it buyssecurities, exchangingmoney forthe

security, it raises themoneysupply. onversely, sellingofsecurities lowers the

moneysupply. Buyingofsecurities thusamounts toprintingnewmoneywhile

loweringsupplyof thespecificsecurity.


10/17

Themainopenmarket operationsare:

Temporary lendingofmoney forcollateralsecurities ("Reverse perations"

or"repurchaseoperations", otherwiseknownas the "repo" market). These

operationsarecarriedout onaregularbasis, where fixedmaturity loans

(of 1 weekand 1 month forthe E B) areauctionedoff.

Buyingorsellingsecurities ("direct operations") onad-hocbasis.

oreignexchangeoperationssuchasforex swaps.

All of these interventionscanalso influence theforeignexchangemarketand

thus theexchangerate. orexample thePeople's Bankof hinaand theBank

of apanhaveonoccasionbought several hundredbillionsofU.S. Treasuries,

presumably inordertostop thedeclineof theU.S. dollarversus

therenminbiand theyen.

[edit]Capital requirements

All banksarerequired toholdacertainpercentageof theirassetsascapital, a

ratewhichmaybeestablishedby thecentral bankorthebankingsupervisor.

orinternational banks, including the membercentral banksof theBank for

International Settlements, the threshold is % (see theBasel apital Accords)

ofrisk-adjustedassets, wherebycertainassets (suchasgovernment bonds)

areconsidered tohave lowerriskandareeitherpartiallyorfullyexcluded from

total assets forthepurposesofcalculatingcapital adequacy. Partlydue to

concernsabout asset inflationandrepurchaseagreements, capital

requirementsmaybeconsideredmoreeffective thandeposit/reserve

requirements inpreventing indefinite lending: whenat the threshold, abank

cannot extendanotherloanwithout acquiring furthercapital on itsbalance

sheet.

[edit] eserverequirements

Inpractice, manybanksarerequired toholdapercentageof theirdeposits

asreserves. Such legal reserverequirementswere introduced in the

nineteenthcentury toreduce theriskofbanksoverextending themselvesand

suffering frombankruns, as thiscould lead toknock-oneffectsonother

banks. See also money multiplier.As theearly 2 thcenturygoldstandardand

late 2 thcenturydollarhegemonyevolved, andasbanksproliferatedand

engaged inmorecomplex transactionsandwereable toprofit fromdealings

globallyonamoment'snotice, thesepracticesbecamemandatory, ifonly to

ensure that therewassome limit on theballooningofmoneysupply. Such

limitshavebecomehardertoenforce. ThePeople's Bankof hinaretains (and


11/17

uses) morepowersoverreservesbecause theyuan that it manages isanon-

convertiblecurrency.

Even ifreserveswerenot a legal requirement, prudencewouldensure that

bankswouldholdacertainpercentageof theirassets in the formofcash

reserves. It iscommon to thinkofcommercial banksaspassivereceiversof

deposits from theircustomersand, formanypurposes, this isstill anaccurate

view.

Thispassiveviewofbankactivity ismisleadingwhen it comes toconsidering

what determines thenation'smoneysupplyandcredit.oanactivitybybanks

playsa fundamental role indetermining themoneysupply. Thecentral-bank

moneyafteraggregatesettlement -final money-can takeonlyoneof two

forms:

physical cash, which israrelyused inwholesale financial markets,

central-bankmoney.

Thecurrencycomponent of themoneysupply is farsmallerthan thedeposit

component. urrencyandbankreserves togethermakeup themonetarybase,

calledM1 and M2.

[edit]E changerequirements

To influence themoneysupply, somecentral banksmayrequire that someor

all foreignexchangereceipts (generally fromexports) beexchanged forthe

local currency. Therate that isused topurchase local currencymaybemarket-

basedorarbitrarilyset by thebank. This tool isgenerallyused incountrieswith

non-convertiblecurrenciesorpartially-convertiblecurrencies. Therecipient of

the local currencymaybeallowed to freelydisposeof the funds, required to

hold the fundswith thecentral bank forsomeperiodof time, orallowed touse

the fundssubject tocertainrestrictions. Inothercases, theability toholdoruse

the foreignexchangemaybeotherwise limited.

In thismethod, moneysupply is increasedby thecentral bankwhen it

purchases the foreigncurrencyby issuing (selling) the local currency. The

central bankmaysubsequentlyreduce themoneysupplybyvariousmeans,

includingsellingbondsorforeignexchange interventions.

[edit]Marginrequirementsandothertools

Insomecountries, central banksmayhaveothertools that work indirectly to

limit lendingpracticesandotherwiserestrict orregulatecapital markets.or

example, acentral bankmayregulatemargin lending, whereby individualsor


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companiesmayborrowagainst pledgedsecurities. Themarginrequirement

establishesaminimumratioof thevalueof thesecurities to theamount

borrowed.

entral banksoftenhaverequirements forthequalityofassets that maybe

heldby financial institutions; theserequirementsmayact asa limit on the

amount ofriskand leveragecreatedby the financial system. These

requirementsmaybedirect, suchasrequiringcertainassets tobearcertain

minimumcredit ratings, orindirect, by thecentral bank lending to

counterpartiesonlywhensecurityofacertainquality ispledgedascollateral.

[edit]E amplesofuse

ThePeople's Bankof hinahasbeen forced intoparticularlyaggressiveand

differentiating tacticsby theextremecomplexityandrapidexpansionof the

economy it manages. It imposedsomeabsoluterestrictionson lending to

specific industries in 2 3, andcontinues torequirebetween 1% and 3% more

reserves[

] from largeurbanbanks (typically focusingonexport) thanrural

ones. This isnot byanymeansanunusual situation. The USAhistoricallyhad

verywiderangesofreserverequirementsbetween itsdozenbranches.

omesticdevelopment is thought tobeoptimizedmostlybyreserve

requirementsratherthanbycapital adequacymethods, since theycanbemore

finely tunedandregionallyvaried.

[edit]Bankingsupervisionandotheractivities

Finance

Financial markets[show]

Financialinstruments[show]

Corporate finance[show]

Personal finance[show]

Public finance[show]

Banks and banking[show]

Financial regulation [show]


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Standards[show

Economic history[show

vde

In some countries a central bank through its subsidiaries controls and monitors

the banking sector. In other countries banking supervision is carried out by a

government department such as the

K Treasury, or an independent

government agency

e.g.

K's Financial Services Authority

. It e amines the

banks' balance sheets and behaviour and policies towardconsumers. Apart

from refinancing, it also provides banks with services such as transfer of

funds, bank notes and coins or foreign currency. Thus it is often described as

thej

bank of banksj

.

k

any countries such as the

nited States will monitor and control the banking

sector through different agencies and for different purposes, although there is

usually significant cooperation between the agencies. For e

ample,money

center banks, deposit-taking institutions, and other types of financial institutions

may be subject to differentand occasionally overlapping

regulation. Some

types of banking regulation may be delegated to other levels of government,

such as state or provincial governments.

Any cartel of banks is particularly closely watched and controlled.k

ost

countries control bank mergers and are wary of concentration in this industry

due to the danger of groupthink and runaway lending bubbles based on

a single point of failure, the credit culture of the few large banks.

[edit]Independence

This section needs

additional citations for verification.Please help improve this article by adding reliable references.

Unsourced material may be challenged and removed. (February2009)

This section may be unbalanced towards certain

viewpoints. Please improve the article by addinginformation on neglected viewpoints, or discuss

the issue on the talk page. (February 2009)

Over the past decade, there has been a trend towards increasing the

independence of central banks as a way of improving long-term economic

performance.l

owever, while a large volume of economic research has been


14/17

done todefine therelationshipbetweencentral bank independenceand

economicperformance, theresultsareambiguous.

Advocatesofcentral bank independenceargue that acentral bankwhich is too

susceptible topolitical directionorpressuremayencourageeconomiccycles

("boomandbust"), aspoliticiansmaybe tempted toboost economicactivity in

advanceofanelection, to thedetriment of the long-termhealthof theeconomy

and thecountry. In thiscontext, independence isusuallydefinedas thecentral

bank'soperational andmanagement independence from thegovernment.

The literatureoncentral bank independencehasdefinedanumberof typesof

independence.

Legal independence

The independenceof thecentral bank isenshrined in law. This typeof independence is limited ina

democraticstate; inalmost all cases thecentral bank isaccountableat some level togovernment

officials, eitherthroughagovernment ministerordirectly toa legislature. Evendefiningdegreesof

legal independencehasproven tobeachallengesince legislation typicallyprovidesonlya

frameworkwithinwhich thegovernment and thecentral bankworkout theirrelationship.m

oal independence

Thecentral bankhas theright toset itsownpolicygoals, whetherinflation targeting, control of the

moneysupply, ormaintaininga fixedexchangerate.n

hile this typeof independence ismore

common, manycentral banksprefertoannounce theirpolicygoals inpartnershipwith the

appropriategovernment departments. This increases the transparencyof thepolicysettingprocess

and thereby increases thecredibilityof thegoalschosenbyprovidingassurance that theywill notbechangedwithout notice. Inaddition, thesettingofcommongoalsbythecentral bankand the

government helps toavoidsituationswheremonetaryand fiscal policyare inconflict; apolicy

combination that isclearlysub-optimal.

Operational independence

Thecentral bankhas the independence todetermine thebest wayofachieving itspolicygoals,

including the typesof instrumentsusedand the timingof theiruse. This is themost common form

ofcentral bank independence. Thegrantingof independence to the Bankof England in 1o o

was,

in fact, thegrantingofoperational independence; the inflation target continued tobeannounced in

the

hancellor'sannual budget speech to Parliament.

Management independence

Thecentral bankhas theauthority torun itsownoperations (appointingstaff, settingbudgets, etc.)

without excessive involvement of thegovernment. Theotherformsof independencearenot

possibleunless thecentral bankhasasignificant degreeofmanagement independence.neof

themost commonstatistical indicatorsused in the literatureasaproxy forcentral bank

independence is the "turn-over-rate" ofcentral bankgovernors. Ifagovernment is in thehabit of


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appointingandreplacing thegovernor frequently, it clearlyhas thecapacity tomicro-manage the

central bank through itschoiceofgovernors.

It isargued that an independent central bankcanruna

morecrediblemonetarypolicy, makingmarket

expectationsmoreresponsive tosignals from the

central bank. Recently, both the Bankof England (1 )

and the European entral Bankhavebeenmade

independent and followaset ofpublishedinflation

targetsso that marketsknowwhat toexpect. Even

thePeople's Bankof hinahasbeenaccordedgreat

latitudedue to thedifficultyofproblems it faces, though

in thePeople's Republicof hina theofficial roleof the

bankremains that ofanational bankratherthana

central bank, underlinedby theofficial refusal to "unpeg"theyuanortorevalue it "underpressure". The People's

Bankof hina's independencecan thusbereadmore

as independence from the USAwhichrules the financial

markets, than from the ommunist Partyof hinawhich

rules thecountry. The fact that the ommunist Party is

not electedalsorelieves thepressure topleasepeople,

increasing its independence.

Governmentsgenerallyhavesomedegreeof influence

overeven "independent" central banks; theaimof

independence isprimarily toprevent short-term

interference. orexample, thechairmanof the U.S.

ederal Reserve Bank isappointedby thePresident of

the U.S. (all nominees forthispost arerecommended

by theownersof the ederal Reserve, asareall the

boardmembers), andhischoicemust beconfirmedby

the ongress.

International organizationssuchas the

orld Bank,

theBISand theIM arestrongsupportersofcentral

bank independence. Thisresults, inpart, fromabelief in

the intrinsicmeritsof increased independence. The

support forindependence from theinternational

organizationsalsoderivespartly from theconnection

between increased independence forthecentral bank


16/17

and increased transparency in the policy-making

process. The I F's FSAP review self-assessment, for

e

ample, includes a number of questions about central

bank independence in the transparency section.An

independent central bank will score higher in the review

than one that is not independent.

[edit]Criticism

According to the Austrian School, central banking tends

to wreak havoc on an economy by systematically

devaluing a currency by over creating this currency

against nothing of intrinsic valuezsuch as gold

{,

resulting in never-ending inflation. The main opponents

to fractional reserve central banking are the proponents

of the Austrian business cycle theory, including Ludwig

von

ises, Friedrich|

ayekand

urray

}

othbard, [9] though this economic theory is not generally

accepted by mainstream economists. F. A. | ayek

shared a Nobel Prize in economicszwith Stockholm

school economist, Gunnar yrdal{ in ~ 974 based on

their pioneering work in the theory of money

among

other contributions.

[edit]AlternativesThis section doesnot cite any references or

sources.Please help improve this article by

adding citations to reliable sources.

Unsourced material may

be challenged and removed. (Nove

mber 2010)

Demurrage currencies provide an alternative and

perhaps complementary means towards central

banking's goal of sustaining economic growth w ith

different specific characteristics and a mechanism that

follows naturally from the use of commodity currencies,

is more uniform in operation, does not devalue the

currency unit, and is more predictable and potentially

more decentralized in its operation.

istorically, the idea

of demurrage influenced Keynes' prescription for net-

inflationary central bank poli


17/17

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