The primary function of a central bank is to manage the nation's money supply (monetary policy), through active duties such as managing interest rates, setting the reserve requirement, and acting as a lender of last resort to the banking sector during times of bank insolvency or financial crisis. Central banks usually also have supervisory powers, intended to prevent bank runs and to reduce the risk that commercial banks and other financial institutions engage in reckless or fraudulent behavior. Central banks in most developed nations are institutionally designed to be independent from political interference.
Central banks implement a country's chosen monetary policy. At the most basic level, this involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency (disallowed for countries with membership of the International Monetary Fund), currency board or a currency union. When a country has its own national currency, this involves the issue of some form of standardized currency, which is essentially a form of promissory note: a promise to exchange the note for "money" under certain circumstances. Historically, this was often a promise to exchange the money for precious metals in some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of the promise to accept that currency to pay for taxes.
A central bank may use another country's currency either directly (in a currency union), or indirectly (a currency board). In the latter case, exemplified by Bulgaria, Hong Kong and Latvia, the local currency is backed at a fixed rate by the central bank's holdings of a foreign currency.
In countries with fiat money, the expression "monetary policy" may refer more narrowly to the interest-rate targets and other active measures undertaken by the monetary authority.
Central banks implement a country's chosen monetary policy. At the most basic level, this involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency (disallowed for countries with membership of the International Monetary Fund), currency board or a currency union. When a country has its own national currency, this involves the issue of some form of standardized currency, which is essentially a form of promissory note: a promise to exchange the note for "money" under certain circumstances. Historically, this was often a promise to exchange the money for precious metals in some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of the promise to accept that currency to pay for taxes.
A central bank may use another country's currency either directly (in a currency union), or indirectly (a currency board). In the latter case, exemplified by Bulgaria, Hong Kong and Latvia, the local currency is backed at a fixed rate by the central bank's holdings of a foreign currency.
In countries with fiat money, the expression "monetary policy" may refer more narrowly to the interest-rate targets and other active measures undertaken by the monetary authority.
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