Duties of Central Banks
Definition of a central bank
Central banks are independent public institutions that are responsible for the monetary policy within their country or geographical area. They are mandated by the State to carry out their duties. The president of each central bank is elected by the representative(s) of the geographical area to which he/she belongs. The main central banks are the FED the ECB, the BoJ and the BoE. Their main objective is to support economic activity while keeping inflation at a reasonable level (not to exceed 2%).
ECB - European Central Bank
The ECB is the central bank of the European Union. It was founded in 1998 and is headquartered in Frankfurt, Germany. The ECB is the central body of the Eurosystem and the European System of Central Banks:
- the Eurosystem comprises the European Central Bank (ECB) and the national central banks (NCBs) of the EU Member States that have adopted the euro. Within the framework of the Eurosystem, the ECB has been entrusted with the tasks previously entrusted to the national central banks: the issuance of currency and monetary policy;
- the European System of Central Banks (ESCB) comprises the ECB and the NCBs of the 27 EU Member States, i.e. in comparison with the Eurosystem, it also includes the NCBs of countries that have not adopted the euro. The NCBs of the Member States not participating in the euro zone enjoy a special status within the ESCB: they are entitled to conduct an autonomous national monetary policy, but they do not participate in decision making on the euro zone's monetary policy or its implementation.
The ECB is an independent body. It receives no external instructions. Its capital may only be held by the national central banks in accordance with a distribution key. This key is based on the share of GDP contributed by each country within the European Union, and their population size. Its initial capital was approximately €4 billion. The central banks of the EU countries have also paid foreign exchange reserves to the ECB. Thus, the ECB can intervene on the foreign exchange market if necessary.
The European Central Bank is composed of the Executive Board (the President, the Vice-President and 4 qualified people). These 6 people are appointed by the European Council, which is currently the highest body of the European Union. The central bank derives its legitimacy and credibility from the appointment of the 6 members of the Executive Board by the European Council.
The Executive Board is the tactical body of the European Central Bank, responsible for implementing the monetary policy decisions taken by the Governing Council (governors of the national central banks of the euro zone and the members of the Executive Board).
The Governing Council is responsible for taking monetary policy decisions. To make these monetary policy decisions, it relies on 2 pillars of analysis: an economic analysis pillar (using economic, monetary and financial news such as exchange rates, growth, debt ratios, budget deficits, etc., providing information on inflation trends) and a monetary analysis pillar with the monitoring of monetary aggregates, mainly M3 (transaction currency + short-term savings + long-term savings), which is the least informative on future inflation, however, this strategy has beenhistorically effective, particularly for the BundesBank.
The ECB submits an annual report to the European Parliament each year, while the Governor of the European Central Bank is heard by the Economic and Monetary Committee of the European Parliament once every quarter. However, it is not possible for the ECB to be sanctioned by the European Parliament.
The basic mandates of the Eurosystem are to:
- define and implement the euro zone’s monetary policy;
- conduct the euro zone's exchange rate policy;
- hold and manage Member States' foreign exchange reserves;
- ensure the proper functioning of payment systems.
In addition, the Eurosystem contributes to the smooth conduct of policies pursued by the competent authorities concerning the prudential supervision of credit institutions and the stability of the financial system.
To this end, it has various means of action at its disposal, which are interest rates. There are three key rates: the refinancing rate, the deposit rate and the marginal lending rate. The refinancing rate (EONIA: European Over Night Index Average) is the main rate, it regulates economic activity by facilitating the injection of liquidity into the market when necessary. Effectively, it is the overnight interest rate that determines the rate at which banks can refinance themselves. It is used as a reference on the money market, this rate being a minimum rate. A lot of rates are correlated with the refinancing rate, including the deposit rate and the marginal lending rate. They are actually the cost of money. They regulate investment and influence credit conditions available to companies and individuals. If rates are low, investors will borrow en masse, as the cost of money is low. It is an economic regulator. In times of crisis, rates are lowered to boost economic activity. Conversely, if inflation is too high, rates are increased in order to reduce inflationary pressure. The deposit rate is the rate at which banks are remunerated for their deposits with the central bank. These deposits correspond to the bank's minimum reserves. The bank is obliged to set aside part of its profits to protect itself from a possible crisis. Banks can freely deposit additional funds to earn interest. This is usually the case in times of crisis, as the ECB is considered risk-free.
Every second Thursday of the month, the governors of the euro zone’s national central banks meet in Frankfurt to take monetary policy decisions. The day before, all governors meet informally.
FED - Federal Reserve Bank
The FED is the central bank of the United States. It is a private institution, owned by the twelve local federal banks (New York, San Francisco, Chicago, Richmond, Atlanta, Boston, Dallas, Cleveland, Philadelphia, Kansas City, Saint-Louis, Minneapolis), which ensures a certain independence from the government. It was created in 1913. The FED is under the authority of its president who is appointed by the President of the United States. The president is then part of the committee composed of the Board of Governors, which takes decisions (Governing Council: 7 members appointed by the President of the United States and approved by the Senate), the President of the Federal Reserve Bank of New York and 4 other Governors of the Federal Reserve Bank on an alternating basis) In terms of its funding, it is totally independent and receives no budget. It is financed by the interest on sovereign bonds to which it subscribes, and by the services it provides for various banks.
Its functions are multiple. It decides on the United States' monetary policy with the aim of promoting the country's economic growth, as well as ensuring full employment and price stability. It must therefore determine the monetary policy to be adopted in the light of all these objectives. The FED's main weapon is the overnight interest rate. The lower the rate, the more favourable monetary creation will be. The FED's decision to change its rates is often taken when the Beige Book is published. This Beige Book is a summary of the state of the American economy. It is based on reports from various local federal reserves, which compile all the economic information relating to their districts. To this end, they interview various experts. The Beige Book includes all the districts. It is published eight times a year, about two weeks before the Monetary Policy Committee meeting. This is the meeting where the FED decides on the actions it will take. When there is strong inflationary pressure, the FED decides to increase its rates to reduce the quantity of money in circulation. They say it tightens the monetary tap. Conversely, in the case of an economy in recession, the FED lowers its rates in an attempt to revive economic activity.
Two other meetings, one at the beginning of the year and the other in the middle, are very important. These 2 meetings, which exceptionally last 2 days, enable the committee to discuss the Monetary Policy Report to Congress, which is in fact a report on American monetary policy submitted by the Chairman of the Board of Governors to American Congress.
The Federal Reserve:
- decides the United States’ monetary policy, with a dual objective of price stability,
- has an obligation to facilitate economic growth,
- supervises the American banking system,
- publishes reports, such as the Beige Book, on the American economy,
- acts as lender of last resort,
- has no responsibility for the external value of its currency, the US dollar.
BoE - Bank of England
The Bank of England (BoE), was founded in 1694 by William Paterson. It is the central bank of the United Kingdom. Its creation has enabled strong commercial development in the country. After being nationalized in 1946, in the aftermath of the Second World War, it regained its independence in 1997 while being regulated by the Financial Service Authority (FSA). This year was also marked by a major turning point in the United Kingdom's monetary policy, as the country also decided to say "no" to the adoption of the euro when it regained its independence. The BoE was then strengthened in its role as a major financial institution. Indeed, as the United Kingdom opted to maintain its national currency, it is able to take advantage of the euro’s low rates to make sterling investments more attractive and to adopt more flexible management than most other European national central banks.
The Bank of England's role is to promote and maintain monetary and financial stability in the United Kingdom, to conduct exchange rate policy, to ensure the distribution of sterling in England and Wales, and to act as a "lender of last resort" to commercial banks.
It is important to note that London is the world's largest financial centre for Forex.
The Bank of England meets once a month, on the 1st Thursday of the month. Its decision on interest rates is made public at 1 o’clock in the afternoon. Unlike the ECB, the BoE does not hold a press conference after its decision. However, like the FED, it publishes a detailed report of the exchanges held between the various members, in the weeks following its meeting. The "Minutes" of the BoE meeting are therefore particularly anticipated by the foreign exchange market, which looks for indications of the future direction of British monetary policy.
BoJ - Bank of Japan
The Bank of Japan (BoJ) was created in 1882 shortly after the “Meiji Restoration", which led to the introduction of a single Japanese currency in 1871, the yen.
The BoJ became independent in April 1998 and its main tasks are to establish the country's monetary policy, manage the issuance of banknotes, ensure Japan's financial stability, publish economic reports and contribute to the balance of international trade.
The Governor of the BoJ is referred to as “Sosai” in Japanese and has a five-year term of office.