Financial stability and the role of central banks

• Author: Gheorghe, C.A.
• Position: Department of Law, Transilvania University of Brasov
• Pages: 123-126

Bulletin of the Transilvania University of Braşov • Vol. 4 (53) •No. 2 - 2011

Series VII: Social Sciences • Law

FINANCIAL STABILITY AND THE ROLE OF

CENTRAL BANKS

Carmen-Adriana GHEORGHE1

Abstract: T he role of central banks in promoting monetary stability is well

known. Modern central banking laws are usually explicit on making

monetary stability the core objective of central banks. Also, other competing

objectives are sometimes added to the central bank’s mandate, such as

growth and full employment.

Key words: financial stability, monetary sta bility, Central banks, the role of

central banks.

1 Department of Law, Transilvania University of Braşov.

1. Introduction

The reason for central bank’s

involvement in the promotion of financial

stability is twofold. First, it is generally

agreed that financial stability is a condition

of monetary stability. A financial crisis

will result in a contraction of the money

supply, which affects monetary stability.

Conversely, too much liquidity is being

created, which generates a risk of inflation,

usually followed by a downturn. Second,

financial crises affect the real economy. As

credit is based on trust, it will dry up if

there is a loss confi dence in debtor’s

solvency. No credit means no investment,

which leads to unemployment and

economic recession. A central bank can

not be indifferent to t hese consequences.

Even if it has not explicit mandate

concerning the real economy, a major

recession will inevitably raise questions

about its usefulness to the country.

2. Central banks – a particular social

institution

Central banks are an archetype of a

particular social institution that is now

faced with a variety of pressing challenges.

Among the principal issues are: the

primacy of price, exchange and financial

stability as objectives, the relative scope of

monetary, regulatory, advisory and

developmental roles of central banks, the

transmission to direct monetary policy

instruments, the conflict between monetary

policy and other roles, the fiscalization of

central banks, organizational r eform of

central banks, the case for divertissement

of their quasi-fiscal activities, scope and

limitations of central bank independence

and of ceilings on credit to government.

The more practical approach is to discuss

the objectives and functions of typical

central banks, which are best regarded as

organizations rather than institutions.

D. North differentiates them as: institutions