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Comparing Central Banks

Apr 9, 2011 • Developing Economies, Economic Debates, Financial Markets, Money and Monetary Policy • 246 Views    No Comments

Perhaps we can divide the world between inflation fighters and recession fighters.

Right now, most of the inflation fighters are in the developing world. In Brazil, Russia, India and China (the BRICs), more expensive food and energy and growing demand are fueling price increases. In Peru and Mexico, the story is the same although the numbers differ. As a result, monetary authorities are raising borrowing rates.

On the other hand, the U.S. Federal Reserve, the Bank of England and the Bank of Japan, are targeting economic growth by keeping rates close to zero

Finally, we do have a third group, including the European Central Bank (ECB) and Australia that is reversing easy money policy with rate hikes

The Economic Lesson

Central banks are the bankers’ banks that oversee a country’s supply of money and credit. For economic growth, you need the right balance between money and production. If the balance is wrong, then the result is recession or inflation or both.

A recession is characterized by a declining GDP and increasing unemployment. To fight it, central banks target lower interest rates that will stimulate economic activity.

By contrast, inflation involves rising prices that can spiral out of control. To stop their ascent, central banks try to use a diminished money supply or slowly growing money supply and higher interest rates to reign in economic activity. With less demand throughout the economy, they hope that prices will stop rising.

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