A central bank, reserve bank or monetary authority is an institution that manages a state's currency, money supply and interest rates. Central banks also usually oversee the commercial banking system of their respective countries. In contrast to a commercial bank, a central bank possesses a monopoly on increasing the monetary base in the state, and usually also prints the national currency, which usually serves as the state's legal tender. Central banks also act as a "lender of last resort" to the banking sector during times of financial crisis. Most central banks usually also have supervisory and regulatory powers to ensure the solvency of member institutions, prevent bank runs and prevent reckless or fraudulent behavior by member banks.
An ideal type (q.v.) rather than a scientific term since no two central banks are precisely alike. Almost all modern countries have a central bank which is a large bank operating either as a direct governmental institution or as a private institution whose management is strictly controlled by the government. Most central banks were established by law as the result of a national financial emergency, such as the collapse of a prior credit expansion (U.S. Federal Reserve Banks), or the desire of the government for more funds than it cares or dares to raise through taxes or private loans (Bank of England). Central banks usually attempt to control interest rates, reserve requirements and note issues of the nation's banks and act as the bank of last resort when other banks are pressed for funds while holding investments which the central bank will discount on demand. By such technical procedures, the central bank attempts to control the quantity of 'money in the broader sense' (q.v.) and thus indirectly influence prices, production and employment. Central bank policies are usually determined by a desire to (1) prevent financial panics, recessions or depressions, usually by the expansion of circulation credit (q.v.), and (2) provide the government with funds to cover any deficits not fully covered by funds from private sources.
The Banker's Bank, by Sheldon Richman, The Goal Is Freedom, 8 May 2009
Reviews the pre-history of the Federal Reserve and its origins in the Progressive Era, with various quotes from The Mystery of Banking (1983) by Murray Rothbard
"The growing consensus among the bankers was to transform the American banking system by establishing a central bank ..." ... While the New York bankers' interest in central banking went back to the late nineteenth century, the Panic of 1907 provided the final impetus for action. Meetings were held, reports were issued, and legislation was drafted—all in the campaign for a European-style bank. Rothbard shows that the principals in this effort were associates of the most important groups in New York banking, particularly "the Morgans, the Rockefellers, and Kuhn Loeb."
Competing Money Supplies, by Lawrence H. White, The Concise Encyclopedia of Economics
Discusses the arguments in favorand against free banking, with multiple private banks issuing their own notes, including historical precedents and proposals for the medium for note redemption
Some economists recommend abolishing many or even all of these legal restrictions. They attribute significant inefficiency and instability in the financial system to the legal restrictions on private banks and to poor central-bank policy, and they view competition as a potential means for compelling money suppliers to be more responsive to the demands of money users. While many economists would like to restrict the discretion given to central banks, the small but growing number of free-banking advocates would like to abolish central banks entirely.
Don't Blame the Thermometer for the Fever, by Sheldon Richman, Freedom Daily, Jan 1999
Discusses President Clinton's calls for worldwide regulations limiting capital movements and a global regime similar to the New Deal, comparing his views on private property with those of Hitler
Like the Great Depression itself, big fluctuations result from government mismanagement of money and credit. Let it not be forgotten that the Great Depression occurred 16 years after the Federal Reserve was set up. The problem is central banking, and the solution is a fully market-based monetary system, including free, competitive banking and the private issuance of currency ... In light of the real causes of inflation and depression, what we need is the repeal of central banking everywhere, deregulation of capital, and full respect for property rights, without which no human rights are possible.
Gold Policy in the 1930s, by Richard Timberlake, The Freeman, May 1999
Discusses U.S. government monetary policies during the 1930s, in particular, the Gold Reserve Act (1934) which allowed FDR to devalue the dollar, the Banking Act (1935) which reformed the FRS and the misguided policies of Treasury Secretary Morgenthau
The operations of just about any monetary system, and especially one with a central bank, are always puzzling to the layman. Consequently, when things go wrong owing to monetary mismanagement by central bankers or some other political intervention, the instigators can ring in "market failure" as an excuse for their personal failures to make the right decisions ... A central bank, like a gold standard, can assume many institutional forms that differ markedly from one another. The 1913 Fed Banks, for example, were regionally autonomous; the Board in Washington was relatively powerless.
Second, by dividing responsibility for lending among thousands of independent bankers, according to their success in attracting deposits, instead of placing it entirely in the hands of one set of officials, the present system reduces the risk of systemic errors: one bad commercial bank needn't spoil the whole bunch, whereas one bad central bank is equivalent to a spoiled bunch of commercial banks. Lastly, central bankers' lending and investment decisions, instead of depending solely on the judgment of technocrats, are likely to be heavily influenced by political considerations ...
Ludwig Edler von Mises, by Roger W. Garrison, Business Cycles and Depressions, 1997
Describes how Mises integrated ideas from the Austrian (Böhm-Bawerk), Swedish (Wicksell) and British Currency schools to develop his business cycle theory and offers explanations as to why the theory has not been accepted within mainstream macroeconomics
Mises recognized, as did Wicksell, that enlightened bank policy would avoid credit expansion, thus minimizing the divergence between the bank rate and the natural rate. Believing, however, that central bank policy as formulated by government officials would be ideologically biased towards cheap credit, Mises favored institutional reform in the direction of free banking.
The gist of Mises's argument is that the booms and busts of the business cycle are not inherent in the workings of the market economy. Such macroeconomic fluctuations in employment, output, and prices have their origin in central bank mismanagement of the money supply and resulting manipulations of interest rates that throw savings and investment out of balance, bringing about investment and related spending patterns that are often found to be unsustainable in the long run.
Everywhere the Great Depression was blamed on capitalism, but Mises countered with ... [The Causes of the Economic Crisis, 1931]. He made a case that central bank policies were responsible for the Great Depression. Namely, artificially stimulating the economy by holding interest rates below market levels and inflating the money supply. When this process slows down, businesses which had become dependent on it face a financial squeeze, and they begin laying people off. Monetary contraction would bring on a severe crisis.
Friedman concluded ... by stating that the central monetary authority, therefore, should adopt a public policy of "a steady rate of growth" in the money supply. "I myself have argued for a rate that would on the average achieve rough stability in the level of prices of final products, which I have estimated would call for something like a 3 to 5 percent per year rate of growth in currency plus all commercial bank deposits ..." But why have a central monetary authority at all? Why not leave money to the market, as would be the case under a completely market-based and market-determined gold standard, for example?
A central-banking structure for the management and control of a gold-backed currency was established in each country by its respective government, either by giving a private bank the monopoly control over gold reserves and issuing banknotes or by establishing a state institution assigned the task of managing the monetary system within the borders of a nation. ... the central bank was entrusted with the maintenance of that gold parity. The means to that end was convertibility on the one hand and purchase of gold by the central bank in unlimited quantities at a fixed price, on the other.
Money and Banking, by Lawrence H. White, The Encyclopedia of Libertarianism, 15 Aug 2008
Discusses some of the issues regarding money, whether state- or privately issued, and banking, including central banks, such as the Federal Reserve, fractional reserve banking and free (fully unregulated) banking
Central banking is prone to causing either an oversupply or undersupply of money, the effects of which are business cycles. Competition would better regulate the supply of money. British "Free Banking School" economists in the 19th century sharply criticized Parliament for protecting the Bank of England against failure and for giving it a monopoly of banknote issue, privileges that turned it from a commercial bank into a central bank. In the United States, Jeffersonian and Jacksonian classical liberals opposed the special privileges of the first and second Banks of the United States.
Money in the 1920s and 1930s, by Richard Timberlake, The Freeman, Apr 1999
Attempts to set the record straight on the economic and monetary events of the 1920s and early 1930s, arguing against both the Austrian view (as expressed by Murray Rothbard) and those who put the blame on stock market speculation
Through the offices of their associated central banks, states monopolize the machinery of money. Each central bank determines within very close tolerances just how much money an economy has and the rate at which the current stock of money will change ... the Fed managers had become enthralled with the idea that production of goods and services initiates and promotes the production of money. Economists sometimes refer to this as the "real bills doctrine." While it has a grain of truth in it when a true gold standard is in place, it has no validity at all in a system dominated by a central bank.
[Cantillon] saw the problems of general banks of a public and private nature such as the South Sea Company, the Bank of England ... He closed his Essai with an indictment of John Law and his system ...
It is then undoubted that a Bank with the complicity of a Minister is able to raise and support the price of public stock and to lower the rate of interest in the State at the pleasure of this Minister when the steps are taken discreetly, and thus payoff the State debt. But these ... are rarely carried out for the sole advantage of the State, and those who take part in them are generally corrupted ...
In 1963, Rothbard published America's Great Depression, applying Misesian business cycle theory to the depression of 1929. His thesis was that a credit inflation in the 1920s, caused by the Federal Reserve and unnoticed by many because it did not manifest itself in higher consumer goods prices, created malinvestments that made the initial crash inevitable. He further argued that the various government interventions of the Hoover administration exacerbated and extended the depression ... He wrote various essays, pamphlets, and a book, The Mystery of Banking, analyzing the inflationary effects of central banking.
So how does new money ever get created and multiplied on net? By injections of new reserves. Only one entity can create new reserves in a fiat money system with a central bank: the central bank. When the Fed conducts open-market operations it adds new net reserves to the system, which enables the money-multiplier process with no offsetting loss in reserves elsewhere. The central bank and only the central bank can do this.
Under the Shadow of Inflationomics, by Hans Sennholz, Mises Daily, 1 Jun 2006
Explains how inflation has its roots in central banking and fiat money, and describes the influence of Keynesian economics on the policies of U.S. presidents from Richard Nixon to George W. Bush
Inflationomics is a basic ideology of our time. Its intellectual roots are very old, growing in Europe during the 17th and 18th centuries ... They produced strong central governments with monetary powers as a means of economic well-being and with central banks to control the money of the country. The Bank of England, which was founded in 1694, set the example for all others. Most European countries followed suit during the 19th century. The United States established the Federal Reserve System in 1913. Today, nearly every country has a central bank or is a member of a central bank system.
Smith: ... Government regulations have restricted the free trade in money. In the 19th century, many people came to believe that a state-sponsored monopoly in the note issue was an indispensable condition for monetary stability because private issuers had no incentive to restrict their issue ... The striking fact is that subsequent experience has shown that the danger of overissue is far greater with central banking! ... The subsequent establishment of central banking throughout the world [after 1844], in fact, has been associated with historically unprecedented rates of inflation.