Functions of a Central Bank

Every country’s central bank watches economic data carefully and adjust the money supply in an effort to keep the economy headed in the right direction. If a central bank allows the economy to expand too rapidly by keeping too much money in circulation, it may cause inflation. If it slows down the economy removing too much money from circulation, an economic recession could result, bringing unemployment and reduced production.

Central banks usually print only enough currency to satisfy the everyday needs of businesses and consumers. Instead of taking deposits and making loans as normal banks do, a central bank controls the economy by increasing or decreasing the country’s money supply. Once customer deposits money in a bank, it becomes available for further lending, a bank’s supply of money for lending is limited by its deposits and its reserve requirements, which are determined by the central bank.

Another way of controlling the money supply is to raise or lower interest rates. When a central bank decides that the economy is growing too slowly, it can reduce the interest rate it charges on the loans to the country’s banks. Alternately, if the economy shows signs of growing too quickly, a central bank can increase the interest rate on its loans to banks, putting the breaks on economic growth.

Probably the most dramatic way of increasing or decreasing the money supply is through open market operations, where a central bank buys and sells large amount of securities, such as government treasury bonds, in the open market.

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