Glossary : Central Banks

A central bank provides financial and banking services for a country's government and commercial banks. It implements the government's monetary policy, as well, by changing interest rates.

The main functions of a central bank are:

• to manage the government's accounts;
• to accept deposits from and grant loans to the commercial banks;
• to issue bank notes;
• to manage the public debt;
• to manage the exchange rate where necessary;
• to influence the interest rate structure and control the money supply;
• to hold the country's reserves of gold and foreign currency;
• to manage dealings with other central banks;
• to act as a lender of last resort to the banking system.

Open market operations

Central banks fulfil two broad roles in their interactions with the money market: they maintain interest rate stability and act as a lender of last resort. Both functions are aimed at compensating for the undesirable effects of purely free market-driven rates. Money market rates that fluctuated wildly from day to day would disrupt the economy. As lender of last resort, central banks maintain market liquidity, ensuring that borrowers always have a source of funds to draw from.

Central banks do not exercise total control over money market interest rates. Rather, they act as another player on the market, albeit the most powerful and influential player.

Central banks intervene in the money market at regular intervals – anything from each day to every two weeks depending on the country. They aim to keep rates stable or to move rates towards a certain target. So, for example, the US Federal Reserve decides on a target level where it thinks the Fed funds rate should be, then borrows and lends in order to bring market interest rates into line.