EXCPR™: Central Banks

CENTRAL BANKS

Management of monetary policy in the state

Central banks define the country's monetary policy and introduce a more flexible and stable monetary and financial system in the face of challenges and obstacles. In its work, the management of central banks relies on all decisions to help promote the health of the economy as well as the stability of the financial system. In this regard, EXCPR Consultancy and Business Management, based in Kuwait, says that by analysing the functions and roles of central banks, it seeks to educate citizens and residents about these roles, in addition to highlighting the financial decisions made by governments on the financial sector and the economy in general. EXCPR CO. says the roles of central banks can be reduced by five directions: monetary policy, stability of the financial system, supervision of financial institutions, payment and settlement, as well as consumer protection.

MONETARY POLICY

The first role of central banks is to implement the state's monetary policy with the aim of creating more jobs, stabilizing prices, and regulating long-term interest rates. The central bank manages the level of short-term interest rates, which will directly affect the state of the country's financial credit. The change in interest rates would have a slight impact on the prices of the capital markets, as well as the exchange rates of some foreign currencies. When average prices of goods and services are stable, changes in the prices of individual goods and services serve as clear evidence of efficient resource allocation, which contributes to higher living standards. Moreover, stable prices encourage savings and capital formation because when the risk of erosion of asset values resulting from inflation is reduced, families are encouraged to save more and companies are encouraged to invest more, which the central bank aims to achieve.

Inflation

Because the country's long-term inflation rate is primarily determined by monetary policy, the central bank can work directly to ensure that the domestic economy benefits from low and stable inflation. Low and stable inflation helps the economy operate efficiently and in high quality. When inflation is low and stable, individuals can keep money without having to worry that high inflation will quickly erode their purchasing power. Moreover, families and companies can make more accurate long-term financial decisions about borrowing, lending and about savings and investment. Longer-term interest rates are also likely to be moderate when inflation is low and stable.

By contrast, deflation — which occurs when prices of goods and services fall, on average — will increase the debt burden of households and companies after adjusting for lower prices. Moreover, if inflation continues near zero, short-term interest rates are also likely to be very low, and monetary policymakers may not be able to cut interest rates enough to support the economy when it is at risk of slipping into recession. As a result, monetary policy aimed at maintaining inflation at 2% in the long run helps maintain a productive and well-functioning economy, leading to increased employment and higher living standards for citizens. In this way, the goal of maximizing employment in the economy is closely linked to inflation of 2%.

Employment

The goal of employment and increasing its numbers is balanced with stable prices as a monetary policy objective. However, policymakers are aware that factors other than monetary policy largely determine the maximum level of employment that can be maintained without leading to higher inflation. These factors include trends in population size, changes in the types of jobs and skills needed in the labor force, and other policies such as those affecting education and training. Monetary policy makers see a range of indicators in making their assessments of labor market conditions consistent with the maximum employment, recognizing that these assessments are necessarily uncertain and may change from time to time. The central bank is supposed to present the necessary reports quarterly on the longer-term outlook for economic activity and unemployment. In these projections, the central bank reports the long-term projected unemployment rate.

As monetary policy actions affect inflation and employment, central bank decisions must be based on their assessment of the medium-term outlook for the economy, with which inflation and employment can improve. In addition, the central bank's periodic reports should include any risks associated with economic expectations, which may threaten the financial system.

Economy

As economic conditions change, central banks keep up with fiscal policies, usually by raising or lowering their interest rate target. The change in the target for the interest rate on funds will usually be accompanied by changes in other interest rates and in financial conditions on a larger scale; these changes will therefore affect spending decisions for families and companies and will therefore have implications for economic growth, employment and inflation.

Capital Markets

Changes in longer-term interest rates usually affect stock prices, and because some small investors have long-term investments in the financial markets, the change in stock prices will have implications for personal wealth. For example, if long-term interest rates fall, investors may decide to buy more shares, thereby raising the market value of listed companies. Furthermore, lower interest rates for investors may lead to the expectation that the economy will be stronger and that profits will be higher in the future, and this expectation may increase demand for equities.

STABILITY OF THE FINANCIAL SYSTEM

Central banks also seek to maintain and stabilize the financial system, in order to reduce and contain risks, through effective monitoring and participation. Central banks monitor the risks of the financial system and participate at home and abroad to help ensure that the system supports a healthy economy for families, communities and local businesses. The financial system is stable when financial institutions — banks, savings, loans and other providers of financial services and products — and financial markets are able to provide families, communities and companies with the resources, services and products they need to invest, grow and participate in a well-functioning economy.

SUPERVISING FINANCIAL INSTITUTIONS

Other key roles of central banks include supervising and regulating financial institutions, which enhances the integrity and performance of their businesses, as well as monitoring their impact on the domestic financial system.

PAYMENT AND SETTLEMENT

Central banks are also promoting the integrity and efficiency of the payment and settlement system through services to the local banking industry. A delicate and highly effective settlement system is vital to the economy and its positive impact on it. The system also facilitates financial transactions, the purchase of goods and services and the accompanying movement of funds at all levels of the local and global economy.

CONSUMER PROTECTION

At the end, central banks are interested in promoting consumer protection and community development by understanding consumer behavior, providing community activities, and managing consumer laws and regulations, which are also central banks' roles and functions in each country. The central bank's management must obtain accurate evidence and facts directly from consumers in order to enhance the results achieved and support the technical reports submitted, which will eventually lead to sound fiscal policies.

Finally, although all the main functions and roles of central banks in each country are known, the existence of the appropriate list of data and the results and facts it contains will confirm the accuracy of the financial decisions taken. In other words, the weakness of the reports and data collected has a role to play in delaying critical decision-making and thus missing more opportunities to develop the state's fiscal policy.