Here we take a look at the uses of central banks, and their influence on politics.

Inflation management

This is the core task and reason they were created; to tame inflation. The goal is to provide some, generally 2%, so that both private and public debt will slowly become less troublesome, whilst not really upsetting the people with high prices. This is mainly done via interest rate setting, sometimes an forward outlook is enough; they don`t actually change anything, just inform the markets of an intend to do so. Naturally some follow through is required, but the suggestion can ease transitions or calm an upset market.

Should be noted that every government can influence inflation to the full simply by managing its own expense, but that might be in direct confrontation with election promises so not a realistic expectation. The idea is also that central banks act independently from politician, so that they are not bound by election promises or other conflicting motives.

Monetary management

The secondary task of most central banks is managing the amount of cash floating around in the system. There are two ways of doing that:

1 Via interest rates: They set rates and a combination of banks+market decide how much lending goes on. A bank van lend out more than what is has in cash deposits, thereby creating cash. Regulations do limit the extent to which a bank can do this.

2 By directly ordering the money presses to be turned on. A recent example is quantitative easing, in which central banks buy exchange traded products. In doing so they have created a global money supply of billions upon billions. After doing so for years, they have stopped both reinvesting and buying, as such reducing the extra money.

Central banks also are the governmental party buying gold, for the guaranteed wealth of that country: In the old days all money was either gold or silver, with gold mostly used for trading and silver for regular expenses (groceries and such). In the modern age, they still buy gold, mostly to hedge against inflation and currency risks: They will use it if their mandate requires it or political overlords muck up so badly that intervention is necessary.

Influence on politics

The decisions of a central bank influence directly what politicians talk about, for the simple reason that their prime concern, inflation, is directly felt by all layers of civilisation. There are also cases of large countries having a big influence on the economies of smaller countries, in which there is a even greater effect; because the big country does not always take the smaller one into consideration*.

In most cases, the central bank reacts to government spending, by attempting to stabilise inflation.

Influence from politics

The difficulty with politicians is that they fail to think ahead; to win voters they have to address short term annoyances, which rarely result in long term gains. This causes them to insist on things like low interest rates, in a already heated market, simply so they can keep spending without directly worrying about the bill. Fortunately most central bankers are independent from political bodies, but given enough time even the most chained down president can find a way to influence policy.

In most cases (we are assuming the position of a stable form of government, presumably a democracy, with this statement) politicians do not directly interfere, for fear of disturbing the market. In a unstable situation you see that high ranking officials not only start removing bankers, and replacing them with puppets, they also exert pressure on monetary policy to get what they want. This cannot possibly result in a sustainable growth situation, not because of short term focus for that can result in real growth, but because a precedent has been set: Bankers must appease the king of the hill, or fear for their jobs.

 

*Though not particularly good sport, we do understand it: It is not the job of the big country`s central bank to actively manage the economy of a different country. In most cases the smaller countries decided to peg their fate to the big country in hopes of reducing financial risks, this is a risk they knowingly took. However, there is direct effect on global trade and the relationship between these countries, so it is something to consider.