The Role of a Regional Bank in a System of Central Banks

A modern central bank seeks to maintain a financial environment withinwhich competitive markets support the efficient use of productiveresources. The overarching principle is that a central bank should provide the necessary monetary and financial stability in a way that leaves the maximum freedom of action to private markets. In keeping with this principle, monetary policy is implemented by indirect means, with an interest rate policy instrument rather than with direct credit controls. In the banking sphere every effort is made to minimize as far as possible the regulatory burden associated with financial oversight. The principle that markets should be given free reign wherever possible creates three difficulties of understanding that a central bank must overcome in order to carry out its policies effectively. The presumption that monetary and banking policies are best when they are as unobtrusive as possible creates the first difficulty. Inevitably, central banks seem shadowy and distant from the public’s point of view. Yet, to work well, central bank policies need to shape the expectations of households and businesses. Monetary policy encour-ages economic growth and stabilizes employment over the business cycle by anchoring inflation and inflation expectations. Bank supervision and regulation aims to promote confidence in the banking system. This article is reprinted as it appeared in the Carnegie-Rochester Conference Series on Pub