The Central Role of Central Banks

Most countries' finances are dominated by their respective central banks. This makes their role, in not only their country but in the world, extremely prominent. They make large, macro policy decisions that affect even the smallest businesses. What role do these policy decisions play in the world though? With globalization and the intermingling of economies across the globe, all of these different policy decisions is sure to dictate how the world interacts.

The policy decision that has dominated central banks for the better part of a decade now is inflation targeting. This is perhaps the most effective tool any central bank holds because of its ability to set interest rates. However, a shift may be taking place among central banks. The governor of the Bank of England, Mark Carney, stated that the inflation targeting perpetuated by central banks over the last several years, “became a dangerous distraction.” He stated that central banks must do more on price stability.

On top of inflation targeting, another question that has surrounded central banks since the financial crisis is stimulus spending. One of the main functions of any central bank is to try to add liquidity into the economy when the market does not seem to be able to. As Europe continues to struggle to find its way out of slow growth, the European Central Bank is eyeing a possible stimulus plan. This includes their own cutting of interest rates to near zero, but they are not yet willing to take on the purchasing of government bonds that the United States Federal Reserve did when the recession hit.

Regardless of the policies put forward by any individual central bank, it has tremendous implications on the global economy. Many multi-national companies operate in Europe and the lowering of interest rates is sure to make executives rethink current capital allocation, as well as borrowing strategies. The web of the world economy is thoroughly intertwined and ever changing.