CENTRAL BANKS AND THE GLOBAL ECONOMY
Introduction
Central banks are autonomous entities with the national authority to formulate monetary policies and regulations, regulate the performance of banks, and offer essential financial services like conducting economic research (Braun, 2017). Central banks play critical roles in stabilizing and boosting the economy of various nations, including stabilizing a country’s currency, exploring better ways of curbing unemployment menace, and preventing any emanating cases of inflation. The history of central banks dates back to the fifteenth century when the Federal Republic of Sweden came up with the first-ever central bank that it called the Riksbank in the year 1668. The bank of England would later be established in the year 1694 owing to the successes of the Swedish Central bank. The bank of England, after its inception, played critical roles in boosting the economy of England. Various nations and territories would later adopt this sublime concept and establish their central banks. Napoleon, at the onset of the nineteenth century, created the Banquet de France, the central bank of the French Nation (Ertürk, 2014). Post-World War II, various nations had established central banks with the European Central Bank being established in the year 1998, leading to an overhaul of all central bans within the Eurozone. A good number of the central banks are managed by a board made up of the member banks. It is mandatory, in most countries, that all operational banks must belong to the central bank. The Executive head of a central bank, referred to as a governor, is appointed by a country’s supreme leader subject to approval by a national legislative body depending on the laws of a country (Dow, 2017). This ensures that central banks operate within the confines of the supreme laws of a country and are focused on meeting the long-term goals and objectives of a country. This also shields the central banks from political impinging since central banks ought to be apolitical to ensure smooth operations. Over the years, several discourses have emanated on the role of central banks in the economy of the globe. Some factions have argued that central banks wield too much power, which is dangerous for the stability of some countries, while other factions have argued that the power wielded by central banks is vital for their diligent operations. In this study, I shall outline the role that central banks play in the global economy with reference to the European Central Bank. I shall further assess whether they wiled too much power and the essence of the powers they wield.
The Role of Central Banks in the Global Economy
Formulation of Monetary Policies
Central banks influence economic growth rates by controlling the rates of liquidity in the financial systems of various countries. To have full control of the rates of liquidity, central banks often apply three basic monetary policy tools (Caballero, 2016). Central banks have set a requirement reserve. A requirement reserve refers to the amount of money that the member banks have to deposit with the central banks each day for their operations to be approved (Braun, 2017). Depending on the client-base of a bank, the central bank sets a reserve for each bank. If a member bank fails to meet its reserve requirement, it forthwith declared bankrupt and placed under receivership. The main purpose of the reserves is to control the amount of money that the central banks can lend to the public. The second monetary policy is the use of open market operations in the buying and selling of securities from its member banks (Dow, 2017). This mechanism changes the cash at hand without interfering with the reserve requirements for the member banks. This mechanism was used in the United States during the financial crisis of the year 2008. Banks in the United States were forced to purchase government propelled bonds and mortgages in a bid to strengthen and hence stabilize the cracked banking system (Orphanides, 2018). The third policy is setting a target on interest rates to the member banks. This guides the rates for loans, bonds, and mortgages that the member banks charge on their clients. When inflation threatens to set in, the central banks raise interest rates, thereby slowing growth and hence reducing inflation. This is commonly known as the contractionary monetary policy. However, lowering interest rates encourages progressive growth and hence eliminating any cases of recession. This is commonly known as the expansionary monetary policy. Monetary policy takes on the lower end, six months for its reeling effects to be felt on a country’s economy (Caballero, 2016). In some cases, central banks have often misinterpreted economic data, thus negatively impacting the economy of the affected countries as it happened in the United States in the year 2006 (Orphanides, 2018). Also, if central banks stimulate an economy too much, inflation may set in under their noses. It is for this reason that central banks shy away from inflation and would do anything within their powers to eliminate inflation (Dow, 2017). Inflation tramps on development and the progressive growth of a nation. It leads to job losses that may create chaos in a country.
Just like other central banks, the European Central Banks is tasked with the role of maintaining and safeguarding the stability of the Euro against other currencies across the globe. The Governing Council of the European Central bank has stated that there are keen on maintaining the stability of the Euro (De Grauwe, 2011). They have defined price stability as an inflation rate that is below two percent but not in any way close to the two percent. The stability of the Euro is critical in expediting economic growth that provides a conducive environment under which more jobs can create for the masses, the main objective and goal of the European Union (Fontan, 2018). In doing so, the European Central Bank enjoys a monopoly in the issuance of banknotes in the whole Euro Area. The ECB influences the amount of money in circulation by controlling the money that it issues to its member banks (De Grauwe, 2011). On a weekly basis, the ECB makes announcements on the amount of money that it will channel to its member banks and the range of interest rates that its member banks are expected to charge on their clients, thus giving the ECB the ability to control inflation within the Eurozone.
Regulation of the Banking Sector
Central banks have a set of laws, regulations, and mechanisms that they use to regulate their member banks. The member banks are in direct contact with the general population, raking in deposits from their clients, advancing loans, bonds and mortgages to the masses hence the need for central banks acting as a watchdog to ensure that their operations are within the confines of the laws of the land, and that, they do not infringe on the rights of their clients through exploitation (Caballero, 2016). The central banks ensure that all its member banks are financially stable, and the deposits made by the clients of the member banks are protected (Braun, 2017). If a member bank is declared bankrupt by the central bank and placed under receivership, the individual customers of the bank will be reimbursed by the central bank. In the regulation of the member banks, central banks come up with policies and laws that its member banks are expected to adhere to. These policies and laws vary from one country to another, depending on the sate of their economy (Dow, 2017). For instance, in the United States, the Federal Bank has prohibited its member banks from owning hedge funds and also bans the banks from using cash from its clients to engage in flimsy business deals for their malicious gains.
The European Central Bank has ensured robustness in the banking sector of the Eurozone. To achieve this robustness, the ECB conducts keen supervision on all banks in the member states of the European Union. To make its supervision efficient, the ECB has the Single Supervisory Mechanism (SSM), a body made up of the ECB and selected banking experts from the member countries (De Grauwe, 2011). To give the ECB ability to execute its operations diligently, the European Union has given the ECB some sense of authority and power. In executing its supervisory mandate, the ECB has the power and authority to strip banks that do not operate within the confines of its policies, their banking licenses (Fontan, 2018). It also has the power to increase the reserve requirements of its member banks to mitigate looming financial crises and also review and rate the member banks. Currently, the ECB directly supervises the operations of one hundred and twenty-four banks within the Eurozone. It is estimated that these banks, under the supervision of the ECB, hold close to eighty percent of the cumulative banking assets within the Eurozone (De Grauwe, 2011).
Provision of Financial Services
Central banks provide financial services to their member banks and the nation at large. Central banks are like the banks of their member banks. Members of the public cannot open accounts with central banks, while licensed banks in various countries have mandatory accounts with the central banks that provide various financial services to them. Most central banks store their currencies in foreign reserves of exchange from where they are able to control their exchange rates in a mechanism dubbed the peg (Caballero, 2016). Central banks regulate exchange rates by providing a range of exchange within which its member banks can draw their rates to enable the central banks to control inflation. To influence and stabilize their currencies against other foreign currencies, central banks buy and sell large quantities of various foreign currencies, thereby affecting the curves of demand and supply (Dow, 2017). Central banks also monitor the economy of their nations and come up with statistical reports that detail the performance of various sectors of the economy. These statistical data are used by the National Treasury of various countries to locate the funds to various sectors of the economy in each fiscal year. The European Central Bank manages the foreign currency reserves of the European Union to ensure the stability of the Euro against the dollar (De Grauwe, 2011). The ECB also advises the government of its Member States on the best courses of action they can explore to ensure progressive growth and increased creation of job opportunities. It is also at the forefront of advocating for the adoption of safe payment systems to reduce the cases of cash pilferage via the internet (Fontan, 2018).
Do Central banks have too much power?
The councils of central banks are always appointed rather than elected officials, but despite their appointment status, they have come out to wield too much political power. These officials, since they operate independently and are an apolitical faction of a Nation, silently influence the economies of various nations and hence the livelihood of the Citizens of various countries. Central banks, in controlling the economies of various nations, determine the budget allocations to various departments of the government (Buiter, 2014). In doing so, they control the rates and salaries that people in different sectors are paid. They further influence the prices of goods and commodities in the market by controlling the costs incurred in the production of goods and the provision of various services (Goodhart and Lastra, 2018). In England, central banks gained too much power after the Great Recession in which it was the center of repairing the economy that was in tatters and on the verge of collapsing. The former deputy governor of the Bank of England, when the financial recession hit in posits that after tackling the financial recession, central banks have emerged as the third pillar of unelected power after the military and the judiciary (Buiter, 2014). Though not elected by the people, they wield too much political power. The power they wield is essential in averting future economic crises (Pixley et al., 2013). However, in some scenarios, the powers that these banks have been entrusted with have been noted to be too much and unnecessary.
At the onset of the major financial crisis that hit the globe between the years 2008 and 2010, the central banks of various nations played a vital role in resuscitating the economy of the globe and bringing it back to its knees. This was a collaborative doing of various central banks in different parts of the globe like the Federal Reserve of the United States, the Bank of England, The European Central Bank, and the Swedish Central Bank among the many other central banks. As the central banks worked round the clock to salvage the global economy, they were completely left on their own with totally no help from the management of various countries (Buiter, 2014). It was termed as a problem of the Central Banks as it was their responsibility to keep the global economy rolling. Some governments even made derogatory remarks that the central banks are independent and should, therefore, not be a pain in the ass of the government. They were under pressure to perform their duties diligently and save companies and organizations from going under and hence shield the masses from job losses (Faust, 2016). The councils of central banks did everything with the constraints of their expertise and abilities to get the global economy back to its toes. After a couple of months, the effects of some of the measures and mechanisms put in place started bearing fruits (Pixley et al., 2013). The global economy had been at the brink of collapse was slowly gaining momentum and traction. Some central banks applied the unorthodox mechanism to resuscitate the global economy, mechanisms that would otherwise be rejected (Buiter, 2014). After the great recession, the central banks merged stronger and more powerful.
The essence of wielding too much power for Central Banks
To maintain a balance between the political cycles and Business Cycles
Politicians are always concerned with staying in power for as long as they can and will always do anything to ensure they remain in power even if their actions are in breach of the supreme laws of the land. It is, therefore, worth noting that the actions of politicians are always controlled by political cycles. When the electioneering periods set in, politicians will always be accommodative to their electorate and independent institutions like the central banks (Faust, 2016). On the other hand, businesses operate via a business cycle. Central banks are majorly concerned with the business cycles that play a direct role in influencing the economies of various countries. On many occasions, the business cycles will coincide with the political cycles during periods of boom and bust (Goodhart and Lastra, 2018). During the electioneering periods, it is common that there will always be high rates of inflation. Politicians, without paying an iota of attention to the economy of their countries, may end up passing skewed policies that further rag the tattered economy as they gain political mileage (Goodhart and Lastra, 2018). However, with the political power that central banks wield, they will be in a position to shun the implementation of such bleak policies. The political power of the central banks gives them the ability to salvage a country’s economy in worst-case scenarios.
Inflation
The primary objective of any central bank is to control inflation and hence to be able to control the economy of the country. In doing so, the central banks must regulate the money spent by the government and advise the government on the sectors into which they need to pump cash released by the central bank (Braun, 2017). If such decisions that are central to the economy of various countries would be within the precincts of the national governments, then the economies of different countries would go under as governments would always make populist decisions (Ertürk, 2014). A good example is when governments would pledge to offer free education and free medical services to its citizens when it actually doesn’t have the financial muscles to implement such gross policies (Faust, 2016). In fact, if most governments were to have the control of the economies of various countries when difficult economic periods set in, they would rather resort to the printing of more money, which would ultimately lead inflation hence the destruction of the economy (Dow, 2017). The political power that the central banks wield is essential to ensure that they are able to mitigate countries from the reeling effects of inflation. In doing so, they would even ignore some directions from the government and implement that which is good for the economy.
Deficit Spending
If governments had full control of monetary policies, they would engage in populist projects that have no economic benefits to the country and hence setting an economy in tatters (Braun, 2017). Governments would spend money without considering any of the fiscal policies that influence the economy. For instance, the government of Brazil once spent billions of dollars on building stadiums to host the world cup and Olympics. In these scenarios, the government of Brazil engaged in deficit spending by spending too much money on projects that had no economic viability or feasibility. If various governments were to be given control over monetary decisions and policies, they would spend much money more than is available on non-viable ventures in order to gain traction of the common voter (Ertürk, 2014). It is therefore vital that central banks are given full control over monetary policies and regulations to ensure that countries are salvaged from economic depressions that arise from poor decisions made by governments. The political powers they wield are therefore necessary and essential to ensure the diligent operations of the banks.
Conclusion
Since the invention of the concept of central banks back in the 15th century, they have been used to transform the economy of various nations and hence the global economy. Central banks have been at the forefront of coming up with effective monetary policies like banking reserves and interest rates on loans, bonds, and mortgages. These policies are useful in controlling the economy of nations that would be damaged in the absence of policies. The central banks also regulate their member banks that are always in direct contact with the general population to cushion the masses from exploitation like exorbitant interest rates. In regulating their member banks, the central banks ensure that each bank operates within the confines of the law. However, central banks have been bashed for wielding too much power despite being unelected officials. In this paper, I have justified the power muscles of central banks by giving detailed reasons why they need to wield such amounts of authority and power.
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