Central banks are national or supranational institutions whose purpose is to ensure financial stability and to act as lenders of last resort. As the International Monetary Fund (IMF) explains, financial stability can be understood in different ways: in the case of the European Central Bank (ECB), the stability objective is primarily to ensure the smooth functioning of the payment system, which includes price control. However, as in the case of the US Federal Reserve (Fed), central bank action has often been aimed at ensuring the stability of the financial system as a whole, sometimes by any means necessary (think of Mario Draghi's famous "whatever it takes").
As has been the case in recent years, central banks intervene to ensure financial stability when it is threatened by destabilising factors, such as a financial crisis (as was the case in the 2008 and 2012 financial crises) or very high inflation (as was the case between 2022 and 2023).
In a crisis situation in which the banking system is at risk of being particularly affected by cascading insolvencies (e.g. companies that are no longer able to refinance themselves), the central bank acts with the aim of ensuring adequate liquidity for the banking and financial system. In this case, two of the central bank's key instruments are worth mentioning: a) interest rates, which have a direct impact on bank lending - due to the central bank's role as lender of last resort - and thus also on the credit market; b) the purchase of bonds, which is another way of injecting liquidity into the financial system. In this sense, both the role of the central bank as lender of last resort and the possible use of another instrument that can be used in this sense, namely the issuance of currency, through the purchase of bonds or the provision of financing, are understood. Taken together, these measures are known as quantitative easing.
In a situation of high inflation, which is rapidly eroding the purchasing power of consumers, savers and businesses, the central bank intervenes by draining liquidity from the system so that the currency slows down its decline in value. Controlling inflation is part of the broader task of maintaining price stability. In the case of some of the world's largest central banks - from the ECB to the Fed - the task is to get inflation to the 2 per cent target over the medium term. Again, one of the key instruments is interest rates: through a transmission system (central bank rates act as a benchmark for bank lending rates), a rise in interest rates leads to an increase in the cost of money and a tightening of liquidity, with the aim of curbing the erosion of the purchasing power of money. The other instrument is to reduce the purchase of bonds. In this case, the term used is quantitative tightening.
Another task of central banks is to regulate the banking and financial system. This is done by laying down rules and prudential criteria (capitalisation, leverage, regulation of certain markets, etc.). In this context, however, we should not forget the importance of the market supervisors, which are crucial bodies for ensuring the reliability and credibility of the financial and banking system.
In addition to the aforementioned ECB and Fed, as well as the national central banks of the euro area, here are some of the most important central banks that are often mentioned in economic and financial news: Bank of England, Bank of Japan, People's Bank of China, Central Bank of Canada, Swiss National Bank, Reserve Bank of Australia, Reserve Bank of New Zealand, Banco Central do Brasil, Reserve Bank of India, South African Reserve Bank, Central Bank of the Russian Federation, Banco Central de México, Sveriges Riksbank, and of course others.
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