The central banks play the following important role in the monetary system of an economy:
a. Monopoly Supplier of the Currency: The central bank of any country has the capacity to print the money, whether it is gold standard or fiat money. The currency based on the gold standard is backed by the gold reserve and can be converted by the holder of the currency. Fiat money, on the other hand, is a non-convertible, legal tender, and exists by the government’s decree.
The central bank also acts as the guardians of the value of the currency. They have to keep control of the degree of inflation in the economy, to maintain confidence in the value of the currency.
b. Banker to the Government and Other Banks: The government maintains the balances with different banks in the economy.
i. So to control the money supply in the economy, it draws down or redeposits the money in these banks.
ii. When the government draws down the currency from the other banks, it deposits the same in the central bank, to decrease the supply of money.
iii. On the other hand, when the government needs to increase the supply of money in the economy, it redeposits the same in the other bank’s accounts.
iv. For the other banks, the central bank also acts as the lender of last resort. That is when in the need for short-term liquidity needs, the banks cannot secure the interbank loans; they can turn up to the central bank to secure the finance.
c. Supervisor of the Banking System.
d. Regulating and overseeing the payments system.
e. Managing a nation’s foreign currency and gold reserves.
f. Operating a nation’s monetary policy.
g. Often, the objective of the central bank is the stability of the financial system and management of the payments system.