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Role of Central Banks

Economics: Edexcel A A Level, topic 8.3.3

Functions of a Central Bank

The main functions of a central bank are:

Implementation of monetary policy

Implementation of monetary policy

Act as a banker to the government

Act as a banker to the government

Act as a banker to the banks

Act as a banker to the banks

  • The central bank is the lender of last resort.
Regulation of the banking industry

Regulation of the banking industry

  • The central bank has a role in regulation of the banking industry.

Bank of England

The Bank of England (BoE) is the central bank of the UK and was made operationally independent in 1997. This means that it is not directly accountable to the government.

Bank of England's objectives

Bank of England's objectives

  • Since becoming independent, inflation (price stability more formally) has been the BoE's target – in 1997 it was set at 2.5%. In 2004, the government changed the Bank’s target to 2%.
  • The BoE is allowed a range of +/- 1 percentage point in the inflation outcome before it has to write a letter to the Chancellor explaining why inflation is away from target, what is being done about it and when we can expect it to be back on target.
  • The UK government has not set a target for the exchange rate since 1992.
Monetary Policy Committee (MPC)

Monetary Policy Committee (MPC)

  • The MPC is the body within the Bank of England that is in charge of achieving price stability.
  • It is made up of nine members – the Governor, the three Deputy Governors for Monetary Policy, Financial Stability and Markets and Banking, the Chief Economist and four external members appointed directly by the Chancellor. 
  • They meet once every six weeks to vote on whether there will be a change to monetary levers or not. The vote is determined by a simple majority with every member having an equal vote.
Factors affecting MPC's decision

Factors affecting MPC's decision

  • Inflation expectations.
  • Consumer spending forecasts.
  • Real GDP growth rate.
  • Exchange rate.
  • Trade balance
  • Consumer and firms’ confidence.
  • State of labour market, full employment, wage pressures – unemployment and employment trends.

Test yourself on Role of Central Banks

  • Which of the following are main functions of central banks?

  • Which bank function makes a central bank the "banker to the banks"?

  • What is the inflation target for the Bank of England set by the government?

  • What is the name of the committee of the Bank of England which decides the base interest rate?

  • How often do the MPC meet?

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