Central banks have a range of functions, including bank supervision (to ensure that they adhere to regulations), payment system oversight and monitoring, and inflation targeting. In addition, they have the power to make money by purchasing assets such as government debt and mortgage-backed securities in order to stimulate the economy. The central bank also communicates the implications of its decisions to manage expectations and enhance transparency.
Inflation Targeting
The central bank determines a desirable long-run price level, and takes action to keep it stable. This involves controlling interest rates and/or the money supply, aiming to reduce inflation volatility and to support growth. Inflation targeting is an important tool because a volatile price level has a negative effect on consumer and investor confidence, reducing the incentive to save and invest.
Monetary Policy Decisions
A key part of monetary policy decision making is gathering, deliberating and assessing the relevant economic information. This includes incoming data, the Bank’s projections and major downside and upside risks. The Governing Council then decides on the appropriate monetary policy stance. The decision is published in a press release four times a year.
The public largely assumes that central bank decisions are independent from politics. Indeed, a large academic literature explores the benefits of independence. However, the literature finds that a formal structure is not in and of itself sufficient to generate independence. Moreover, studies of the decisions made by the Bank of England, Federal Reserve and European Central Bank show that they tend to reach their decisions by consensus. In particular, the three central banks value reaching unanimity when deciding on interest rates, and especially when tightening or loosening monetary policy.