The Role Of Central Banks

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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 …show more content…
“A central bank’s extension of credit to banks during a financial crisis creates, as a by-product, a large quantity of excess reserves” (ibid., 2). It increases the amount of reserves in the system by the same amount that was lent. On the other hand, central banks can increase the interest rates that it pays on reserves, which increases market interest rates and slows down inflation without modifying the total amount of reserves (ibid., …show more content…
When the Federal Reserve System first established in 1913 in the United States, the primary goal was to provide an “elastic currency”, because the world, at the time, was still operating under the gold standard, which provided stability in the value of the currency. But when it became impossible to maintain the gold standard in the 1930s after World War I and the beginning of the Great Depression, the world started to operate under a fiat regime, which made price stability priority for the central banks since the gold system was no longer in effect to control prices (Plosser, 2014). “Fiat money […] allowed central banks to expand without any clear constraints, on a permanent basis and with impunity, though at the cost of persistent inflation” (Selgin, 2010, 495). According to Selgin (2010), they did not prevent financial crises, nor did they reduce their severity. He believes that they are not less frequent now than before central banks, and that many of today’s crises can actually be blamed on central banks poor management of the money supply (ibid.,

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