What are central banks?

Today, central banks are pretty much universal, it seems that every country has one. Some, such as our own Bank of England, go back to 1694, others are more modern, such  as the Bank of Canada, opening in 1935. But what are they, and why do they exist?

Central banks can be private banks, granted certain monopoly privileges (and responsibilities) that do not apply to other banks in the market, or they can be fully state-owned. The Bank of England is currently “independent” but it is still an arm of the government, and not a private bank.

Central banks are given the task of maintaining financial stability and low inflation amongst other responsibilities. All too frequently, they tend to cause the exact opposite, as I will show throughout this blog.

There are 3 key roles that by which the Bank of England causes trouble:

  • Setting interest rates by fiat
  • Quantitative easing (aka printing money)
  • Being a lender of last resort

Two other problematic government interventions in banking are legal tender laws and deposit insurance, but these are not the sole remit of the BoE.

I’ll explore these in future posts – but it is important to note that all of these are functions that would not exist in a free market – they are only possible through government intervention. So whilst the BoE’s actions can (and often does) benefit the big commercial banks at the expense of other companies and the ordinary consumer, this is only possible due to various government granted monopoly privileges. Often the banking industry is assumed to be the heart of capitalism, but our current system would be far more accurately described as socialist. It most definitely is not a free market!

It’s important to distinguish these roles of central banks from the productions of coins and banknotes, which are not necessarily inflationary if produced in a like-for-like replacement process.

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