What is a Central Bank?

Definition: A central bank is a monetary institution, which fully controls the production, circulation, and the supply of money in the market, seeking to regulate the member banks and stabilize a nation’s economy and national currency.

What Does Central Bank Mean?

What is the definition of central bank? Central banks are responsible for the monetary policy implemented in a country, which includes decisions about interest rates, liquidity control, reserve requirements, and open market operations. When the monetary policy is effective, the centralized bank manages to keep the unemployment rate at low levels, and it stabilizes inflation and interest rates to stimulate economic growth. Although most centralized banks are governed by a board of member banks, they act independently. Also, the decisions of a centralized bank have a strong impact on every aspect of the economy, seeking to meet the nation’s long-term goals.

Let’s look at an example.


Fed in the United States and the European Centralized Bank in the European Union are responsible for controlling the liquidity of the market by implementing monetary policy measures. To achieve this goal, they use three main monetary policy tools, which are the interest rates, the reserve requirements, and the open market operations.

Central banks set short-term target interest rates pertaining to bonds, mortgages, and lending. If the centralized bank raises the interest rates, fewer banks will want to borrow from the central bank, thereby slowing down consumer lending and business lending. On the other hand, higher interest rates prevent inflation from rising further because the supply of money to the market slows down. Therefore, central banks use interest rates to control lending and borrowing in an economy.

Reserve requirements are the funds that a centralized bank must hold in reserve against specific liability types, such as net transaction accounts and nonpersonal time deposits. The Fed’s reserve requirements are 3% of liabilities for net transaction accounts between $15.5 million and $115.1 million, and 10% of liabilities for net transaction accounts of more than $115.1 million. In fact, reserve requirements offer an indication of how much money member banks can lend.

Finally, open market operations are used for the purchase and sale of securities such as Treasury bonds from member banks. By purchasing securities, the central bank increases the supply of money in the market, whereas by selling securities, it lowers the circulation of money in an economy.

Summary Definition

Define Central Banks: Central bank means a financial system allows one institution to control its money supply and interest rates.