Central Banks have become essential parts of modern states. Their monetary policy announcements are seen as major elements of macroeconomic policy and have tangible effects. Nevert

Central Banks have become essential parts of modern states. Their monetary policy announcements are seen as major elements of macroeconomic policy and have tangible effects. Nevertheless, their role is not limited to changing the cost of credit in order to influence consumer prices and economic activity. They play a major role in organising and regulating the payment system, to ensure that means of payment, whether paper or electronic, can be used throughout a country in a secure manner. They are also concerned with financial stability. Their role in financial stability concerns banking supervision, for which many Central Banks are responsible. But it is also about acting as a lender of last resort during banking crises to prevent crises from spreading and the financial system from collapsing. Finally, they are also vigilant to ensure that their monetary policy decisions do not encourage speculative bubbles or, on the contrary, create liquidity crises in the financial markets.

Another raison d’être of Central Banks in many countries is the commitment to maintain a fixed exchange rate, i.e. the guarantee that domestic currency can be exchanged into foreign currency at a constant value. Governments decide on the official value of the exchange rate (or its degree of flexibility) and Central Banks are then responsible for selling or buying foreign currencies to limit fluctuations in the value of the currency as much as possible. If these main functions (monetary policy, financial stability, payments system stability, exchange rate management) are well known and present in all economics textbooks, central banks have played other roles historically, which are often underestimated: public debt management, management of the Treasury account or accounts of other major financial institutions, production of statistics, research and financial information, sectoral credit policy aimed at favouring certain sectors or companies, direct loans to non-financial companies in normal times or in times of crisis, etc.

The roles of Central Banks have often tended to expand historically because of their two major characteristics: they are banks and they are linked - in various legal and administrative ways - to the state. The name of a Central Bank has a literal meaning. It is a “bank”: its main activity is therefore to lend. It is “central” in the sense that it is through it that other banks can interact, both in normal times and in times of crisis. The fact that the Central Bank is the bank of the banks tends to increase its activity if banking stability or development are seen as important policy objectives. It also necessarily creates moral hazard, implied by Central Bank support to the banking sector. But the fact that it is a bank also means that it can substitute for the banking sector in some cases (and not just provide liquidity to banks) to lend to companies or the state. In many countries the central bank was initially the main bank of the country and thus assumed a lending role, similar to that of a private bank or a public investment bank. The fact that the Central Bank is also linked to the state also implies that the latter may tend to entrust it with more and more tasks, including public service tasks that have nothing to do with financing or monetary policy, such as the production of statistics or financial information. There may also be a strong temptation for the State to use the Central Bank not only for the management of the Treasury account but also for the direct or indirect financing of the public debt.

Available at: https://www.parisschoolofeconomics.eu/docs/monnet- eric/history-of-central-banks_oxford.pdf. Retrieved on: May 13, 2024. Adapted.

In the fragment in the first paragraph of the text, the words in bold “about acting as a lender of last resort during banking crises” can be respectively replaced, without any change in meaning, by: