Exam 12: Roles and Services of the Federal Reserve and Other Central Banks Around the World

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Most modern central banks, at least those in major industrialized economies, perform four interrelated functions: (1) controlling the nation's money supply; (2) stabilizing the money and capital markets; (3) serving as a lender of last resort for financial institutions in need of reserves; and (4) maintaining the nation's payments mechanism.
Money supply control is important to minimize the dangers of inflation, while market stabilization is critical to assure a smooth and continuous flow of funds from savings into investment to support economic growth. Service as a lender of last resort helps central banks moderate liquidity pressure in
the financial system. Support of the payments mechanism assures continuous business activity and trade without interruption or long delays.

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The principal goals of monetary policy are a reasonably stable price level (i.e., absence of severe inflation), full employment, sustainable economic growth and a stable balance of payments position. Unfortunately, policies designed to promote some of these goals often aggravate problems in trying to pursue other goals. For example, credit restraint and high interest rates designed to cool off inflation and improve the U.S. balance of payments frequently result in rising unemployment and a slower rate of economic growth. Policy-makers, including Federal Reserve officials, must compromise in pursuing these major goals.