Central Bank & Federal Reserve: Definition, Goals & Functions

Central bank

The Central Bank (Federal Reserve in United Sates) is a banking institution whose function is to formulate and execute monetary policy, exchange policy, regulate and promote the liquidity of the currency. In short, its functions revolve around monetary policies and price stability of the economy.

A central bank is the body responsible for managing monetary policy. It is the institution that regulates the money supply and internal credit and the issuance of currency in legal tender of a country or a group of countries, it’s the lender of the financial system.

The main objectives of a Central Bank or Federal Reserve

The fundamental objectives of the Central Bank are:

To contribute to the economic development of the country. It must stimulate production and issue money according to the volume of transactions carried out by the economic activity.
To preserve the value of currency. This is done by issuing adequate money to ensure that the value is maintained and not devalued. This is why the Central Bank has to achieve a balance between the needs of money to stimulate production without the currency losing value. The central bank of the United States is commonly known as the Federal Reserve.

Functions of a central bank

For an adequate fulfillment of its objectives, the Central Bank has the function of formulating and executing monetary policy, exchange policy, regulating and promoting the liquidity of the currency, in short, its functions revolve around monetary policies and price stability of the economy. The functions are:

To formulate and execute monetary policy.
To participate in the design and execution of the exchange policy.
To regulate credit and interest rates in the financial system.
To regulate the currency and promote adequate liquidity in the financial system.
To centralize and manage the international monetary reserves.
To estimate the adequate level of international reserves.
To participate in the foreign exchange market and monitor and regulate it, under the terms agreed.
To ensure the proper functioning of the country’s payment system and establish its operating standards.
To exclusively exercise the power to issue monetary species.
To advise the national public powers in matters of their competence.
To exercise the rights and assume the obligations in the International Monetary Fund, as provided in the corresponding agreements and in the law.
To participate, regulate and carry out operations in the gold market.
To collect, produce and publish the main economic, monetary, financial, exchange, price, and balance of payments statistics.
To promote actions that encourage solidarity, citizen participation and social co-responsibility, in order to contribute to the development of the population and its socioeconomic training.
To carry out the other operations and services in accordance with the law.

The central bank and the management of monetary policy

The Central Bank manages the monetary policy through open market operations that generally consists of buying and selling State treasuries and other securities in exchange for money and thus increasing the amount of money held by the public. Otherwise, if it wants to reduce the amount of public money, the Central Bank sells the State treasuries in exchange for money and thus reduces said amount.

Increase and decrease in the money supply

In its graphical representation below, in the first case where the quantity of money held by the public is increased, the level of production and prices rise and the LM curve shifts to the right.In the second case where the quantity of money is decreased, demand and prices decrease, and the curve shifts to the right left.