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Central Bank

  A central bank acts as a banker to the commercial banking system and often to the government as well. It is usually a government-owned and operated institution that controls the banking system and is the sole authority for issuing money.

Every country has a central bank, or shares one (for example, in the French African Community). In the United States it is the Federal Reserve, in the UK the Bank of England, in Germany the Bundesbank and in Japan the Bank of Japan. Central banks stand uncomfortably at the point where fiscal policy and monetary control meet, ensuring that the government has the finances to meet its bills, and serving the public debt that results. Central banks have little or no control of fiscal policy; but they do operate monetary policy and oversee the financial system. The role of the central bank may be divided into four areas:

(1) As banker to the government. Public expenditure on goods and services typically accounts for 40% of gross domestic product (and more if transfer payments are included). A government deposits its revenues and reserve currencies with the central bank and pays its bills with central bank cheques. The central bank typically charges the government a fee for acting as its bank: this is one of its major sources of revenue.

(2) As banker to the banks. The central bank takes deposits from banks and lends to them. This function helps the central bank to control the supply of money, but also helps it to maintain the stability of the financial system. The central bank acts as lender of last resort, that is, it stands ready to provide any bank with cash should it be in difficulty, or if its customers want to withdraw their deposits. This safety net enables banks to borrow short and lend long, without losing sleep over it. Often central banks control bank lending by setting a fixed proportion of deposits that must be deposited at the central bank.

(3) As supervisor of the banks. Central banks usually have a say over who can operate as a bank or take the public\'s deposits. They regularly check the banks\' balance sheets and, either by law or by gentle persuasion, force financial institutions to toe the line.

(4) Issuing currency, and offering a guiding hand in foreign exchange markets. Designing, printing, issuing and withdrawing notes (and often coins as well) is the job of the central bank. In consultation with the government, and with other central banks, the central bank intervenes in currency markets to smooth fluctuation or to protect a target value. Central banks can also nudge currencies either way by shifting interest rates up or down relative to those prevailing in other countries. TF



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