Central Banks And Its Impact On The Economy Essay

871 Words Nov 13th, 2014 4 Pages
Today, most countries function under a regime of fiat money, in which a national currency has value based on government claims that it does. Operating in a fractional reserve banking system where banks only keep a fraction of all their deposits in reserve, it is the role of central banks to protect and preserve its value and ensure its stability (Plosser, 2014). Central banks play a very important role in the fractional reserve banking system, because their goal is to limit the freedom of banks and prevent bank failures without completely limiting banks to performing “storage” services like 100% reserve banking would. However, many disagree with the existence of central banks, as some argue that they cause more economic instability than the opposite.
The Bank of England was founded in 1694. It was the first central bank to assume to role of lender of last resort during the financial crisis of 1857 (Selgin, 2010). It also acted as lender of last resort in the 1878 crisis. Since the latter had considerably larger reserves than some other banks, the Bank of England sent large amounts of reserves to struggling banks as loans, in an attempt prevent further bank runs (Collins, 1989). Those who believe in the efficiency of central banks argue that they can increase economic stability during both depression and inflation.
During periods of economic turmoil, central banks typically lower their interest rates towards other banks, which allows the latter to also reduce their interest…

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