Central Bank

CENTRAL BANK. By a central bank is meant an institu tion upon which has been conferred, by law or custom, the re sponsibility for the smooth running of the credit and currency system of a particular area. Since this task means in practice that all the other banks and organizations in the money market in question must be able to turn to it for assistance in critical times, such a bank becomes "central" both in the figurative sense that it is the final source of aid, and in the literal sense that the working of the money market is intimately and constantly affected by the manner in which the central bank, holding the ultimate cash reserve and possessed of the right of note-issue, interprets its responsibilities, that is, by the "central bank policy" it actively pursues.

The period of reconstruction since the World War has witnessed a remarkable growth in the number of separate institutions acting as Central Banks, as well as important alterations in the powers and practices of certain banks already in existence in pre-war days. The movement in this respect is indeed world-wide. Taking first the British dominions, the South African Reserve Bank was set up in 192o, and the Commonwealth Bank of Australia was re organized in 1924; the Presidency Banks of India were amalga mated in 1920, and the 1926 Commission on Indian Currency and Finance proposed a Reserve Bank for India, the constitution of which is still in dispute. In Canada rediscount facilities, though not a central bank, were provided under war emergency legislation and have now been made permanent. In South America new banks have been created in Peru (1922), Guatemala and Chile (1925), and a new bank was founded in Mexico (1925). In Europe, new banks were founded or alterations were made in the existing banks in Russia (1921), Lithuania, Latvia and Austria (1922), Danzig (1923), Germany, Poland and Hungary (1924), Czechoslovakia and Albania (1925), Belgium and Italy (1926).

The movement is only in part to be explained by the territorial changes which have followed the war, and the currency difficulties which were caused by it. These factors explain why, when devalua tion and stabilization of the standard were decided upon, the reserve requirements were altered; they do not explain why the movement has acquired such momentum in the newer countries, which in pre-war days were content to enjoy the facilities for rediscount offered by the older money markets—in particular the facilities of the London money market.

Central Cash Reserve.

The fundamental factor is the recog nition that a central bank is a prime requisite for the adequate functioning of the banking and currency system of a given coun try. First, the absence of a central bank involves decentralized cash reserves, and experience shows that decentralization of reserves is expensive and ineffective, because in the absence of co-operation each bank requires to hold more, and the larger amount it holds is not available except for its own needs, so that the strong cannot help the weak, whilst the failure of the weaker banks imperils the position of the others. Secondly, it becomes possible to replenish reserves by rediscounting at the central bank, so that the lock-up of funds in holding cash reserves is still further reduced. Thirdly, since a domestic drain on cash reserves repre sents a demand for legal tender rather than for gold, the percent age cash reserves which the central bank need itself hold is still further reduced, the cash reserve of the central bank being deter mined with reference to foreign, rather than to domestic demands for gold. Fourthly, since demands for cash are concentrated at a single point, and are associated in the variations in the volume of loans demanded from the central bank, the ebb and flow of currency and credit are under constant supervision by a single authority, so that remedial measures can be applied more rapidly and more effectively. Fifthly, the central bank acts as a centre of information, control and censorship, so that the self-interest of the parts can be checked by the more disinterested action of the central monetary authority, whilst in periods of crisis there is a technical and moral authority ready to assume responsibility. Sixthly, from the standpoint of the international monetary situa tion, the initiation of a common policy becomes much easier if there are centres through which appropriate action can he under taken.

Control of Price.

In the opinion of many authorities, the most important problem awaiting solution in the field of applied economics is the control of the price level. Two somewhat dis similar issues are involved here : the elimination of short-period or cyclical fluctuations in the value of money, and the elimination of changes in the long-period price level. It is argued that the machinery by which the central bank maintains the local currency at a fixed value in terms of a single commodity ; i.e. gold, is also available for keeping the value of the local currency constant in terms of a group of commodities. Thus the extension of function involved in the elimination of price changes involves questions not of kind, but only of degree ; the technique only requires to be applied to a new end.

If this is admitted the degree of success attained must still turn on the efficacy of the technical means available. Experience has shown that the practical working of central banks is not so ca pable of assimilation to general rules as was formerly thought, for in pre-war days central banks were confined to a smaller number of countries which had the same general economic characteristics. In the newer countries one fundamental condition usually present in the older areas is largely absent : a highly developed use of bills of exchange. This fact, combined with a reluctance on the part of commercial banks to make use of the credit facilities available, deprives the central bank of its power to influence market rates of interest by means of variations in discount rates, and has forced to the front the complementary method of exerting influ ence—the so-called open market policy, by which variations in the volume of securities held by the central bank are made to play the part formerly held by variations in the volume of bills dis counted. Even in the older areas "rationing" of credit has been of late years often preferred to raising the discount rate in the attempt to control borrowing. Moreover, in the newer countries the general relations between the central bank and the other banks in the money market have not yet been satisfactorily adjusted. If the central banks are to carry out their functions adequately, they must control at all times a certain amount of the business of the money market. Yet, if they do so, their actions may easily be interpreted in an unfriendly spirit, and they may be accused of extending beyond their "natural" sphere. Again, it may be open to doubt whether all of these banks can command the necessary experience and trained personnel, whether their relations with the State are always healthy, and, finally, whether the area over which their control extends is always sufficiently large and self-contained to warrant the setting-up of elaborate machinery.

International Credit Co-operation.

The increase in the number of central banks is also likely to complicate the task of international co-operation between them. As pre-visaged by the Genoa Conference, co-operation was to take the form of confer ences, whilst the end desired was co-ordination of reserve policy with a view to avoiding a "scramble for gold" and abrupt changes in its value. So far no conference has met ; instead there has developed an informal co-operation between the governors of the Banks of England and France, the New York Reserve Bank and the Reichsbank. This has not escaped criticism, especially in the United States; but the difficulty of arriving at a common policy would obviously be still greater if the number of partici pants were largely increased and the negotiations were publicly conducted. Apart from the informal co-operation alluded to, the Bank of England has in late years played an important, though largely unrecorded, role as censor and guide to the central banks of those European countries whose currencies were emerging from the post-war chaos.

From the technical standpoint, central bank structure has in recent years been powerfully influenced by the Federal Reserve System. This has been particularly the case in South America. The characteristic features most frequently drawn on are compul sory stock-ownership and compulsory holding of deposits at the central bank by the commercial banks of the country. The principle of forcing the central bank to hold specific reserves against its deposits is also taken from Reserve Bank practice; it has been adopted; e.g., in Peru, Germany, and South Africa. But modern central bank practice as a whole rests upon three main ideas : economy in gold reserves, elasticity of note issue, and, in the fixing of reserve proportion, the assimilation of note issues and deposits; i.e. the reserve is maintained against the sum of the notes and deposits. Safeguards are provided in the limitation of the amount of reserves other than gold which may be kept, and in the provision that excess issues of notes shall be taxable; whilst the amount of the tax must be added to the discount rate, so as to discourage borrowing at such a time. At present one of the features of the balance sheet of many central banks is the high proportion of Government debt to the total interest-bearing assets of the bank. This circumstance is due to inflationary war-finance, by which the note issues of the banks increased, increased Govern ment indebtedness being held as an asset against them. Fear of the repetition of such practices has led in some cases to a very strict limitation of the right of the Government to borrow from the bank in future (e.g. in Germany, Austria, Hungary, Czecho slovakia). On the other hand, the stabilization of currency at low gold values (devaluation) has had the effect of greatly im proving the reserve ratio in certain cases by revaluation at the new stabilization rate, and thus obviating pressure on the free gold reserves of the world. (See BANKING AND CREDIT; MONEY;