The evolution of central banking

Institutions known as central banks emerged or were established as commercial banks or government banks. Their evolution into central banks came with their monopoly issuing notes and their role as lender of last resort, among other functions. Carrying out commercial business on a large scale created a conflict of interest, so this practice was abandoned. Establishing the right degree of dependence was difficult, and changed in times of crisis. Independence is important: it helps to establish reputation, which is everything in banking. The Great Depression, widely attributed to inept Central Bank behavior, interrupted central bank independence, but poor price behavior brought about its return. In the 19th century, laissez faire and the gold standard encouraged and sometimes allowed for considerable independence. Greater changes came in the new dirigiste environment following the Great Depression and the rise of the managed economy. Economies in transition confront high inflation and the problem of maintaining monetary stability just as newly independent developing countries did in the 1960s. How can inflation be controlled? Under fiat regimes, the money supply is controlled by the domestic monetary authority. But can they control monetary growth? Prior and current records are not encouraging. Will authorities have the credibility they need? Options include maintaining a fixed exchange rate or reviving currency boards. Currency boards function like an independent central bank, holding reserves and tying domestic currency to strong foreign currency. There are drawbacks to currency boards, especially for countries in transition. They require a considerable sacrifice of sovereignty, and are unlikely to appeal to countries that are only beginning to recover lost sovereignty.