Meet the People Who Control the World's Money

By Kimberly Amadeo   Updated January 29, 2022  Reviewed By Erika Rasure

What is a central bank? An independent national authority. Conducts monetary policy, regulates banks, and provides financial services like economic research. Goals include stabilizing the nation's currency, keeping unemployment low, and preventing inflation. Most are governed by a board made up of its member banks

A central bank is an independent national authority that conducts monetary policy, regulates banks, and provides financial services including economic research. Its goals are to stabilize the nation's currency, keep unemployment low, and prevent inflation.

Most central banks are governed by a board consisting of its member banks. The country's chief elected official appoints the director. The national legislative body approves them. That keeps the central bank aligned with the nation's long-term policy goals. At the same time, it's free of political influence in its day-to-day operations. The Bank of England first established that model. Conspiracy theories to the contrary, that's also who owns the U.S. Federal Reserve: no one.1

Monetary Policy

Central banks affect economic growth by controlling the liquidity in the financial system. They have three monetary policy tools to achieve this goal.

First, they set a reserve requirement. It's the amount of cash that member banks must have on hand each night.2 The central bank uses it to control how much banks can lend.

Second, they use open market operations to buy and sell securities from member banks. It changes the amount of cash on hand without changing the reserve requirement. They used this tool during the 2008 financial crisis. Banks bought government bonds and mortgage-backed securities to stabilize the banking system. The Federal Reserve added $4 trillion to its balance sheet with quantitative easing.3 It began reducing this stockpile in October 2017.

Third, they set targets on interest rates they charge their member banks. That guides rates for loans, mortgages, and bonds. Raising interest rates slows growth, preventing inflation. That's known as contractionary monetary policy. Lowering rates stimulates growth, preventing or shortening a recession. That's called expansionary monetary policy. The European Central Bank lowered rates so far that they became negative.4

Monetary policy is tricky. It takes about six months for the effects to trickle through the economy. Banks can misread economic data as the Fed did in 2006. It thought the subprime mortgage meltdown would only affect housing. It waited to lower the fed funds rate. By the time the Fed lowered rates, it was already too late.5

But if central banks stimulate the economy too much, they can trigger inflation.6 Central banks avoid inflation like the plague. Ongoing inflation destroys any benefits of growth. It raises prices for consumers, increases costs for businesses, and eats up any profits. Central banks must work hard to keep interest rates high enough to prevent it.

Politicians and sometimes the general public are suspicious of central banks. That's because they usually operate independently of elected officials. They often are unpopular in their attempt to heal the economy. For example, Federal Reserve Chairman Paul Volcker (served from 1979-1987) sent interest rates skyrocketing.7 It was the only cure to runaway inflation. Critics lambasted him. Central bank actions are often poorly understood, raising the level of suspicion.

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