Central Bank: Definition & Purpose

Instructor: Aaron Hill

Aaron has worked in the financial industry for 14 years and has Accounting & Economics degree and masters in Business Administration. He is an accredited wealth manager.

Learn who controls all the money in the United States. Find out what the main functions of a central bank are and how it impacts your ability to get a job, the interest you pay on your car loan, and more.

Definition

Have you ever wondered who was in charge of all the money in the United States? Who determines how much interest you pay for a car loan? How about your house payment? Who actually produces the physical dollar bills that are right now sitting in your wallet? The answer to those questions can be found in the definition of the central bank.

A central bank is a bank that oversees the money system of a nation. The central bank in the U.S. is known as the Federal Reserve and is often referred to as the Fed.

The Federal Reserve System was created in 1913 and is composed of a Board of Governors and twelve regional Federal Reserve Banks in cities such as Kansas City, Dallas, New York, and Atlanta. The head of the Federal Reserve is known as the Chairman. You may have heard of some of the most recent chairmen such as Alan Greenspan, Ben Bernake, and Janet Yellen. Many people in the financial industry believe the chairman of the Federal Reserve is the most powerful person in the world!

A few of the other most powerful central banks in the world are the European Central Bank , the Bank of England, and the Bank of Japan. Let's now look at the main purpose of central banks, with a focus on the Federal Reserve of the United States.

Purpose of the Central Bank

Supervise and regulate banks and financial institutions

The central bank makes sure regular banks have adequate money to pay their customers. This is often referred to as reserves. Although rare in the United States, sometimes too many customers will withdraw their savings from a particular bank and it will run out of money; the Federal Reserve can step in and loan the bank money to satisfy and pay its customers in times of distress.

The central bank is also responsible for ensuring that banks are treating customers fairly and charging appropriate interest rates on loans. The consumer rights and protection you get when you use an ATM machine, credit or debit card, or when you get a car loan, are all regulations the Federal Reserve creates and monitors.

Implement monetary policy

The central bank regulates how much actual money is circulating in the country, which also can affect the interest rates we pay. The central bank can change interest rates and the amounts that banks have to keep in their vaults (reserves). These things affect how quickly the economy can grow and how much a bank charges you for that car loan you wanted. If the bank has to borrow money at a higher rate, they will pass along a higher rate to you so that they can make money.

Maintain healthy levels of inflation

Can you imagine if cars doubled in price next year or if a gallon of milk cost $12 next month when you went grocery shopping? Most central banks and the Fed try to keep inflation at 2% to 3% annually. Inflation is the general rise in the price of everyday goods that we purchase. In order to maintain a stable financial system, it is important for people to know that prices aren't going to double or triple overnight. Inflation is closely tied with monetary policy and is manipulated based on the Fed changing the amount of money in circulation.

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