Central Bank Definition: Day Trading Terminology

A central bank is a modern national institution that oversees some combination of currency management, monetary policy and banking regulation. The exact role and structure of a central bank varies from country to country, but the general purpose of economic and financial management and oversight is the defining characteristic.

Structure and Political Independence of Central Banks

Central banks around the world represent a broad range of mixtures of public and private management and ownership. Some central banks, such as the US Federal Reserve, are largely made up of representatives from the private banking sector, while other central banks are managed mostly by political appointees.

Regardless of the origins of a central bank’s managers, a central bank’s political independence is seen as an essential element of its proper functioning. The power that a central bank has over an economy’s short term prospects is seen as too tempting to leave in the hands of elected officials who face regular elections, and must be managed by independent officials whose mandate is the long term health of a country’s economy and financial system.

That said, even the most robust and independent central banks face short term political pressures, and their political independence remains a constant tension within modern nations.

The Roles of a Central Bank

While the exact duties of a central bank will vary from one country to the next, the roles of a central bank generally fall into three categories.

The Money Supply, Interest Rates and Inflation Targeting

A central bank will control the actual creation and distribution of physical and digital currency, which is closely linked with its mandate for the control of the rate of inflation and interest rates. A central bank has a number of monetary policy tool at its disposal for the control of the interest rates and the attempt to meet inflation targets, though the success of the latter effort varies widely both within and between different countries.

Banking Oversight

They will regulate the activities of the national banking sector to ensure safe and sound practices. The central bank will also use its ability to control capital reserve requirements (the amount of capital that a bank must hold in reserve with the central bank to meet obligations) as a monetary policy tool.

Emergency Lender

A central bank is seen as a stabilizing entity for both private banks and governments by acting as a lender of last resort for failing financial institutions that are seen as ‘systemically important’ to the basic functioning of the national economy and financial system.

Final Thoughts

They hold such a position of power in a modern economy that the words and actions of important officials are monitored and scrutinized for any hint of future actions or policy changes, often even more so than the activities of top elected officials.

Every trader, regardless of their individual trading strategies or preferred asset classes, should be aware of relevant central bank activity, and pay particular attention to pronouncements that have a direct impact on the assets that they trade.