Central Bank: Roles, Policies, and Impact on the Economy
Central Bank: Roles, Policies, and Economic Impact
The Central Bank is an autonomous and independent institution responsible for ensuring currency stability and the normal functioning of internal and external payments.
Autonomy Goals
- Currency Stability: Ensuring the stability of the currency, preventing its deterioration due to inflation. The Central Bank’s priority is to maintain low and stable inflation.
- Normal Functioning of Domestic Payments: Facilitating transactions within the economy through a set of institutions and instruments.
- Normal Functioning of External Payments: Managing external payment transactions between residents of a country and others, recorded in the balance of payments without exchange restrictions.
Central Bank Policies
- Monetary Policy: Protecting the value of the national currency (e.g., the peso) by maintaining low and stable inflation. This contributes to sustained economic growth, full employment, and overall societal welfare. (Price stability with low and stable inflation).
- Exchange Policy: Keeping inflation within the target range, reflecting market confidence in the authority’s ability to independently determine the currency’s value.
- Financial Policy: Acting as the lender of last resort, providing liquidity to institutions facing temporary cash flow problems. The Central Bank also regulates interest payments on current accounts and credit ratios.
Transmission Mechanisms and Policy Horizon
Policy actions are based on expected inflation trends over approximately two years, not solely on current behavior.
Characteristics of Monetary Policy Conduct
Transparency is crucial in the Central Bank’s policy implementation.
Conducting Monetary Policy Operations
The Central Bank implements monetary policy by setting a target level for the interbank interest rate, known as the Monetary Policy Rate (MPR).
Structure of the Central Bank
The current Central Bank Act defines the roles of the General Manager, the Prosecutor, and the Auditor General, in addition to the President and Vice President.
The General Manager oversees the Bank’s administration, the Prosecutor ensures legal compliance of the Bank’s agreements and contracts, and the General Auditor inspects and supervises the Bank’s accounts and operations. Both the General Manager and the Prosecutor have the right to speak at Council meetings.
Key Functions
- Issuance of banknotes and coins.
- Regulation of the amount of money in circulation and credit.
- Regulation of the financial system and capital market.
- Authority for prudential financial system stability:
- Granting emergency appropriations to banking firms and financial companies facing temporary liquidity issues.
- Granting loans or acquiring assets from entities undergoing liquidation or forced agreement proposals.
Impact of High Interest Rates on the Economy
When the Central Bank sets a high interest rate:
- Loan applications decrease.
- The financial system is restricted from issuing a large number of loans.
- Debtors seek to prepay debts to avoid high interest payments.
- Investment is discouraged, and businesses postpone expansion plans.
- Production costs and business risks increase.
Impact of Declining Interest Rates
When interest rates decline:
- Loan applications are encouraged.
- Businesses are incentivized to increase their stock, potentially at a lower cost.
- There is an expansionary effect on the economy.
- Prices of goods and services may rise due to increased demand.