1

The Central Bank's Vital Role and Independence in Fostering Economic Stability and
Growth
 
Department of Business Administration, University of the People
Bus 2203: Public Finance-1
Geetika Arora (Instructor)
July 19, 2023
 2

Introduction

The central bank is an essential entity in every country's economic and financial system. It

performs vital tasks that have an impact on the stability and growth of the economy. Controlling

the currency supply and reserves, supervising the banking sector, acting as a lender of last resort,

and formulating monetary policy are some of these responsibilities. The concept of central bank

independence is also very important. The independence of the central bank from outside

interference, especially from the government, when it comes to making monetary decisions is

alluded to. In order to maintain price stability, promote market trust, take long-term policy

actions, and ensure accountability and openness, independence is required. In this essay, we'll

look at the significance of the central bank and its independence in fostering a robust and

prosperous economy. (Monetary Policy and Central Banking, n.d.)

Importance of the Central Bank

The central bank of a country has a significant impact on a variety of vital aspects of that

country's economic system, such as:

1. Monetary Policy: One of the central bank's primary duties is to create and implement

monetary policy. This calls for controlling the money supply, interest rates, and inflation

in order to preserve price stability and foster economic growth. By altering significant

policy rates, such as the benchmark interest rate, the central bank can have an impact on

borrowing costs, investment options, and overall economic activity.(The Investopedia

Team,2023).

2. Banking Supervision and Regulations: In its function as the watchdog and regulator of

banks and financial institutions, the central bank protects the stability and soundness of
 3

the banking system. It establishes prudential rules, conducts regular inspections, and

monitors compliance to keep the public confident in the banking sector. (Intro to Bank

Supervision and Regulation: In Plain English, n.d.)

3. Lender of Last Resort: When there is a financial crisis or a lack of liquidity, the central

bank serves as the lender of last resort. By providing banks and other financial

institutions with emergency liquidity support, prevents systemic disruptions, promotes

financial stability, and averts bank runs. (Bank, 2022)

4. Currency Issuance and Management: The central bank may issue and oversee the

country's currency. It regulates foreign exchange reserves, ensures there is adequate

money in circulation, and upholds the quality of banknotes. This function fosters

economic activity, facilitates internal and international trade, and enhances the credibility

of the currency.

Central Bank Independence and its Importance

The important capacity of the central bank to make monetary policy choices without undue

intervention from other parties, especially the government, is referred to as central bank

independence. This independence has a number of important advantages:

1. Price Stability: Central banks must be independent for the price environment to remain

steady. Without being influenced by political factors, an independent central bank can

prioritize maintaining price stability and controlling inflation. Difficult decisions, like

raising interest rates to counter inflationary pressures, can be made without heavy

political interference.

2. Credibility and Market Confidence: The credibility and repute of a central bank's

monetary policy decisions are improved by its independence. Market confidence is

increased by sending a message to the markets and investors that policies are based on

economic fundamentals rather than political objectives. As a result, uncertainty is

diminished, long-term investments are encouraged, and steady economic growth is

supported.

3. Long-Term Policy Orientation: Independent central banks can choose a long-term

policy orientation because they are not subject to immediate political pressure. This

allows them to focus on implementing measures that encourage long-term, sustainable

economic growth rather than adopt populist measures that might have favorable short-

term results but unfavorable long-term ones.

4. Accountability and Transparency: Absolute autonomy is not the same as independence

from the central bank. Independent central banks are nonetheless held accountable by the

public and the government for achieving their mandated objectives, such as price

stability. However, they are capable of operating independently of customary political

influence, upholding transparency in policymaking and communication, and enhancing

their reputation and effectiveness.

Conclusion

The independence of the central bank is necessary for the correct execution of monetary policy,

assurance of financial stability, and promotion of long-term economic growth. The role of the

central bank in the economy is significant. The central bank greatly contributes to the stability

and prosperity of the economy by being dedicated to price stability, responsible banking

oversight, and transparent communication.

References

Bank, E. C. (2022, November 12). What is a lender of last resort? European Central Bank.

https://www.ecb.europa.eu/ecb/educational/explainers/tell-me-more/html/what-is-a-lender-of-

last-resort.en.html.

Intro to Bank Supervision and Regulation: In Plain English. (n.d.). Federal Reserve Supervision

and Regulation Introduction | in Plain English | St. Louis Fed.

https://www.stlouisfed.org/in-plain-english/introduction-to-supervision-and-regulation..

Monetary Policy and Central Banking. (n.d.). IMF.

https://www.imf.org/en/About/Factsheets/Sheets/2023/monetary-policy-and-central-banking.