We live in an age of monetary economics. When you work for someone, he pays you in cash and not in kind. When you want to buy a new cow or bicycle, you provide cash instead of goods. The days of barter are gone. Money has a big impact on our lives. To make sense of what is going around, we must understand not only the functions of commercial banks, but also that of central banks as well. In a previous article, we looked at the functions of commercial banks.

Practically, every nation has a central bank. Even before Nyasaland became the independent State of Malawi, the president had to make provisions for the country to have its own central bank.

What is a central bank? A central bank is generally defined as a financial institution charged with the responsibility of supervising the monetary system of a nation. A financial system is a group of individuals or bodies corporate that are involved in transacting money matters, receiving or paying, lending or borrowing money. These groups of institutions are commercial banks, investment banks, insurance firms and so on. The work of all these is under the scrutiny and guidance of a central bank.

Invariably, a central bank is a state institution. Its functions are as follows;

(1). To control the issue of notes and coins. It is these that constitute the country’s legal tender, the money to be used for settling debts within the country or any other country which chooses to use them. In the latter case, we see that US dollar being used as legal tender by some countries apart from the United States itself.

(2). It has the power to control the supply of money in the economy by either direct or indirect means. In monetary economies, money means more than banks notes and coins. Bank deposits fulfill the function of money as a means of settling debts.

(3). Preferably a central bank should also exercise some control over non-bank financial firms, especially intermediaries which provide credit.

(4). The central bank uses relevant tools to control;

(a). Credit expansion: There should be loans to enable the economy grow but not too much to make it bust

(b). Liquidity funds or ready cash: Should be available to pay for short-term transactions such as wages and imports.

(c). The money supply of the economy: Too much money generates inflation, too little causes deflation.

(5). A central bank plays the role of the lender of last resort to prevent commercial banks becoming insolvent. That is when a commercial bank runs out of cash to pay its own creditors such as depositors.

(6). A central bank acts as the government’s banker and administers the country’s national debt.

(7). The central bank acts as the official agent to the government in dealing with its reserves of gold and foreign currency.

How monetary policy works

There are five macroeconomic policies conducted by government.

(a). Monetary policy: Has to do with the action taken by central banks to influence the availability and the cost of money as well as credit by controlling some measure or measures of the money supply or the level and structure of interest rates.

(b). Fiscal policy: This has to do with the level of government expenditure and taxation. That is how governments raise their revenue and how they spend it.

(c). Exchange rate policy: This has been the most topical policy in Malawi during the past three years or so. That is whether to devalue the kwacha against the dollar, pound and the euro. Devaluation make imports more expensive, exports more competitive. Revaluation has the opposite effects.

(d). A prices and incomes policy: This policy is intended to influence the inflation rate by either statutory or voluntary restrictions upon increases in wages, dividends or prices. What is to be the minimum wage? What prices will statutory corporations such as water boards, electricity corporations charge?

(e). National debt management policy: Government borrows money from the financial market by issuing Treasury bills or bonds. They have to be repaid at given times such as after 99 days. National debt management policy is concerned with the manipulation of the outstanding stock of government debt with the objective of influencing the level and structure of interest rates.

The main objectives of economic and monetary policy are;

(a). High employment: This is a major goal of economic policy. Political parties use the appropriate policy to win elections.

(b). Price stability: Keeping prices steady obviates the costs of inflation.

(c). Interest rate stability: Expected higher interest levels discourage investment.

(d). Financial market stability: A collapse of financial markets can affect the economy adversely as was witnessed by the meltdown in North America or Europe in 2000 and 2008.

(e). Stability in foreign exchange market: Unreliable foreign exchange rates make engagement in exports and imports difficult.