gE Blog Series: Central Bank Regulation Part 1 - The Role of Central Banks in the Global Economy

Global interest rates currently span a wide range; from Switzerland, at a negative 0.75%, to Belarus at 28.5%. Overall, 45% of the world’s central banks lowered their rates in the last year, 29% increased their rates, and the remaining 26% left their rates unchanged. Central banks are often nationalized institutions that are usually independent from the government, but whose privileges are established and protected by law.

What separates a central bank from other financial institutions is that they have the ability to issue bank notes and cash, whereas other institutions do not. A central bank has 3 primary functions: manage the growth of national monetary aggregates, act as an emergency lender to distressed financial institutions, and offer wider financing flexibility to the central government.

Monetary policy includes a central bank’s management of money supply and interest rates, but the fiscal policy is determined by a country’s central government, and encompasses how a government would earn and spend money. Central banks are able to enact monetary policy through controlling the money supply and interest rates, thus manipulating the financial liquidity in the economy. These actions help determine and play a role in a country’s currency stability, levels of inflation, and employment.

There are a few types of interest rates, but the critical rates are the LIBOR interest rate and the central banks’s interest rate. The LIBOR interest rate is the average interest rate between 18 central banks, that are prepared to lend one another unsecured funds denominated in various currencies. The central bank’s interest rate is the rate that the central bank of a country or region would use to lend money to commercial banks, and is considered to be the official interest rate for that particular country or region.

Central banks have many tools at their disposal to regulate the economy, and specific policies can have wide-ranging impacts felt around the globe. Stay tuned the remainder of the week, for a look at central bank regulations by region, with focuses on Western Europe, Central America, East Asia, and North America.