From financing wars to inflation targeting: a brief history of central banks

Central banks are institutions that issue currency, provide banking services to governments and commercial banks and have responsibility over monetary policy, including setting short-term policy rates (at which they provide short-term liquidity to commercial banks through monetary operations). Often central banks have responsibilities relating to financial stability, which sometimes include regulating and supervising commercial banks and, more recently, resolving banks that are failing.

Central bank legal frameworks vary considerably from country to country, largely reflecting differences in attitudes shaped by diverse historical experiences. A key feature of the European Central Bank (ECB), unlike the United Kingdom’s Bank of England (BoE) and the United States’ Federal Reserve (the Fed), is that it is explicitly prohibited by the Treaty on the Functioning of the European Union (Article 123 – known as the monetary financing prohibition) from financing government deficits. Moreover, although all three central banks have mandates in which price stability is central, price stability is the ECB’s overarching objective: it can support other goals, including financial stability, growth and employment, only to the extent that they do not interfere with price stability. By contrast, the Fed has a dual mandate set in law: it aims to maximize employment and stabilize prices (as well as moderate long-term interest rates). The Bank of England’s objectives are set annually by the government, however. Ever since the bank was granted operational independence, in 1997, the main aim of monetary policy has been the achievement of low and stable inflation; other government objectives, including employment and growth, have been subordinated to price stability – very much like the ECB. Nevertheless, although, in the BoE case, the mandate can be changed by the government in any given year, the ECB’s mandate cannot change without a revision in the TFEU; such a change requires unanimous agreement by all EU member states.

The Swedish Riksbank was the first institution recognized as a central bank. It was established in 1668 as a joint-stock bank, and chartered to lend funds to the government and to act as a clearing house for commerce.