The Central Bank
A central bank manages the money supply and short-term interest rates to pursue stable prices and a healthy economy. It is the bank to commercial banks and the government, and its independence helps it resist short-term political pressure.
Why it matters
By changing how cheap or scarce bank reserves are, the central bank nudges the whole structure of interest rates and, through it, spending and inflation. An open market purchase of securities injects reserves and eases the short rate.
Worked examples
How does an open market purchase affect bank reserves and the short-term rate?
The central bank buys securities and pays with newly created reserves, raising banking-system reserves. With more reserves available, the overnight rate falls.
Common mistakes
- ✗The central bank prints all the money people hold. Most money is created by commercial banks as deposits when they lend.
- ✗Central bank independence means no accountability. Independent central banks still operate under a legislated mandate and report to the public.
Revision bullets
- •Manages money supply and short-term rates
- •Bank to the banks and to the government
- •Targets price stability, with independence aiding credibility
Quick check
An open market purchase by the central bank
Connected topics
Sources
- Mishkin (2018), Ch. 14Mishkin, F. S. The Economics of Money, Banking, and Financial Markets. 12th ed. Pearson, 2018. ISBN 978-1-292-26885-9.The structure, role, and independence of central banks.