Question

3. Historically, what goals were mandated for central banks?

Why have the goals pursued in recent years been narrowed to “inflation targeting”?

Answer 1

Central banking history dates back at least to the seventeenth century, when the Swedish Riksbank, the first institution recognized as a central bank, was established. Established as a joint stock bank in 1668, it was chartered to lend government funds and act as a commercial clearing house. A few decades later (1694), the Bank of England, the most prominent central bank of the period, was also established to purchase government debt as a joint stock company. Other central banks were later set up for similar purposes in Europe, although some were set up to deal with financial disarray.

For example, Napoleon set up the Banque de France in 1800 to regulate the currency following the hyperinflation of paper money during the French Revolution, as well as to assist in government financing. Early central banks issued private bills that acted as currency and often had a monopoly on the issue of such bills. While these early central banks helped fund the debt of the state, they were also private entities engaged in banking activities. Since they kept other banks ' deposits, they came to work as bankers, facilitate transactions between banks or provide other banking services. In the face of a financial crisis, these factors helped them to become the lender of last resort. In other words, in times of financial crisis, they were able to provide emergency cash to their correspondents.

Before 1914, central banks did not add great weight to the goal of preserving the stability of the domestic economy. After World War I, this changed when they started to worry about employment, real activity, and price level. The shift represented a change in many countries ' political economy suffrage grew, labor movements increased, and migration controls were being put in place. In the 1920s, the Fed began to focus on both external stability (which meant keeping an eye on gold reserves, as the US was still on the gold standard) and internal stability (which meant keeping an eye on costs, production, and jobs).

Targeting inflation is a monetary policy where a central bank sets a specific target for medium-term inflation rate and declares this target for inflation to the public. The presumption is that preserving price stability is the best that monetary policy can do to support the economy's long-term growth. The central bank, the primary short-term financial instrument, uses interest rates. Depending on above-target or below-target inflation, an inflation-targeting central bank will increase or lower interest rates respectively. The conventional wisdom is that rising interest rates typically cools down the economy to rein in inflation; decreasing interest rates generally speeds up the economy, raising inflation. New Zealand, Canada, and the United Kingdom were the first three countries to introduce full-fledged inflation targeting in the early 1990s, while Germany had introduced a range of inflation targeting elements earlier.