Central Banks in Times of Financial Crisis

Introduction

In a country, central bank is in charge of the flow of money in the economy. Furthermore, it is also responsible for control of currency value among other currency related issue in a country. Though commercial banks are also responsible for circulation of money in an economy, they are indirectly controlled by the central bank because they are supplied and financed by the central bank. The central bank is also the banker of commercial banks. Financial crisis cannot be forecasted hence it is an uncertainty in financial operation. In case financial crisis arises, the general public must panic, but the central bank has the responsibility of restoring order and assuring the public that the economy is not at risk despite the crisis. Though controlling public panic might not be easy considering how different people value their investments, and amount each individual have invested, the central bank has the duty of restoring and maintaining confidence among the general public. There are different measures that a central bank may take to restore and maintain public confidence in times of financial crisis. This is a report on measures that central banks may take to control public panic in times of financial crisis.

Financial crisis

The financial crisis is an aspect that can greatly affect the economy of a country. However, the entire nation depends on the measures taken by the central bank to control it and restore and maintain confidence among the public. Financial crisis causes panic among the public due to its effects on the economy and cost of living among other factors that are determined or controlled financially. There are several measures that central banks may take control financial crisis and maintain confidence among the public. Though there are several measures that can be taken by central banks to control financial crisis, there are only two measures that can effectively control financial crisis. The measures that can be taken by central banks and effectively control financial crisis are fiscal and monetary policies. These policies have different reactions to the financial crisis that can effectively control it since financial crisis cannot be avoided. Though both measures can be taken to control financial crisis, central banks can only implement monetary policy effectively. This is because central banks are in charge of the money supply in an economy (Goldblatt 52).

Monetary policies

The central bank is the monetary authority in charge of the money supply in different countries. This policy is basically adopted by banks to ensure stability of prices and reduce levels of unemployment. There are different monetary policies that can be adopted by a central bank to ensure it maintains confidence among the general public in case of financial crisis. A central bank may decide to adopt an expansionary or contractionary monetary policy depending with the financial crisis prevailing in the respective country. These policies are also applied depending with the cause of the financial crisis. Basically, expansionary monetary policy is a policy that if adopted by central banks then it leads to increase in supply of money in the economy than usual. On the other hand, contractionary monetary policy is a policy that if adopted by the central bank then it leads to expansion of money supply in the economy slowly than usual. It can also lead to shrinking of the money supply in the economy. Moreover, these policies are used to counter different effects of financial crisis. This is because financial crisis may lead to different effects depending with its causes. Expansionary monetary policy is basically adapted to control recession and the rate of unemployment. It achieves this by reducing rate of interest. On the other hand, contractionary monetary policy is adopted with an aim of controlling inflation in a country and its effects on the economy of the respective countries. There are different ways how central banks may execute these policies and ensure it maintains public confidence during the financial crisis (Brown 54).

Monetary policies are set with different targets. Generally, monetary policy is adopted depending with the prevailing effects of the financial crisis. These effects are also determined by the causes of the respective financial crisis. A policy may be adopted with an aim of combating different effects, for instance, inflation, mixed policy, gold standard, price level, fixed rate of exchange and the price level (Goldblatt 65).

Inflation targeting

The financial crisis may lead to inflation in a country. However, it is the duty of financial authority, for instance, central bank to ensure that the inflation is contained and despite public panic their confidence is maintained. The central bank may contain inflation by reviewing its rate of interest. A central bank may increase the rate of interest for commercial banks to ensure a decrease in the supply of money in the economy because it will reduce commercial banks lending. On the other hand, a central bank may reduce interest rates on lending for commercial banks to ensure an increase in money supplied in the economy. This is because a decrease in the rate of interest for commercial banks will ensure an increase in the supply of money in the economy hence stabilizing the economy. This approach was basically applied in New Zealand and has ever since been applied by several central banks in different countries, for instance, Czech Republic, Brazil, India, South Africa and United Kingdom among others. This policy has greatly assisted these countries respond to the financial crisis in their respective countries through adoption of the policy by their central banks (Bowdin 74).

Fixed rate of exchange

The financial crisis may also be caused by the value of a currency in the global exchange market and the rate at which it exchanges the foreign currencies. This policy may be adopted to ensure stability of currency in relation to other currencies or a foreign currency. A central bank may decide to adopt the policy hence enforce dollarization policy. This policy encourages use of a foreign currency as the major medium of exchange. The policy can be adopted by a central bank in case it does not trust its local currency and strength or influence in the global market. This policy may greatly assist in stabilization of prices and attracting investors. There are several central banks that have adopted the policy to ensure that the financial crisis is effectively responded to and its effects controlled. This policy has been adopted by most African states to control financial crisis and maintain confidence among the public despite the panic (Brown 93).

Gold standard

This is also one of the most common policies that are adopted by most central banks. This is due to the response of the policy to the financial crisis. This policy adopts the principle of measuring the local currency in gold bar units. This measure is basically stabilized by a government promise of selling and buying gold at fixed prices. Though this policy is effective and efficiently responds to the financial crisis, it is no longer in use by central banks. This policy was mainly used in the mid nineteenth century. This policy was mainly used by most central banks in the past because it was the simplest to understand and implement. It was also transparent hence could easily be explained to economic stakeholders for better understanding. This policy induces deflation, which might lengthen the time spent by an economy in responding to the recession and or financial crisis. Therefore, though the policy is not presently used or applied by central banks, it was greatly used by most central banks in the past to effectively respond to the financial crisis and maintain confidence among the public despite the panic during the financial crisis (Goldblatt 78).

Conclusion

The financial crisis may face any country despite their economic status or position in the global economy. The financial crisis is uncertain and therefore requires flexible monetary policies to effectively respond and combat it. During financial crises, public may panic. However, it is the duty of the central bank to maintain confidence among the public. There are different policies that central banks may adopt to maintain confidence among the public during the financial crisis. They are fiscal and monetary policies, but central banks can only implement monetary policy directly being in charge of the money supply in respective countries. Furthermore, there are different sub policies under monetary policy that can be adopted by central banks depending with the prevailing effects of the financial crisis. They include expansionary and contractionary policies. Basically, contractionary reduces the money supply while expansionary increases money supply in the economy. Therefore, there are different measures that can be adopted by central banks during the financial crisis and their adoption depends with the prevailing effects on the respective economies.

Works Cited

Bowdin, Glenn. Financial crisis and Central Banks. New York: Springer, 2009. Print.

Brown, Arnold. Financial crisis: Monetary policy. New Jersey: World Future Society, 2011. Print.

Goldblatt, Joe. Coping with Financial crisis. Cambridge: Cambridge UP, 2010. Print.

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