All eyes on central bankers
By Peter Diekmeyer • Bankrate.com

In recent weeks, central bank efforts to stabilize financial markets in the wake of the US real estate sector implosion have increasingly made headlines. The American government and the US Federal Reserve are pumping hundreds of billions of dollars into the economy. In early October, the Fed, the Bank of Canada and several European monetary authorities organized what amounts to the first coordinated global policy interest rate cut since just after September 11, 2001.

Here in Canada, the central bank also launched new measures to boost liquidity. While the jury is still out on how well these efforts will succeed, the moves brought to centre stage a group of quiet bureaucrats who wield enormous influence.

Despite the effect of central bank actions on world economies, surprisingly few Canadians have more than a fleeting idea of how they operate. Part of the reason for this is that Canadians continue to have great confidence in their banking system and its regulators. And they may have a point. According to a recently released report sponsored by the World Economic Forum, Canada ranks first among 134 rated nations in terms of the quality of its banking system.

That said, given the Bank of Canada's increasing presence in highly volatile financial markets, it pays to take a closer look at how the organization works and what its mandate is.

Throw those economics textbooks out the window
These days, the first thing those who want to learn about how central banks operate should do is to throw their old economics textbooks out the window. Standard definitions of the roles of monetary authorities include maintenance of national currency and money supply stability, controlling interest rate policy and acting as a lender of last resort to the banking sector. However, turmoil in the financial system has spread so deep that none of the world's central banks can do any of those things on their own any more.

Financial markets have become so constricted that when central banks cut their policy rates, they have increasingly less effect on bank lending practices. As for acting as "lender of last resort" to the banking system, in recent weeks, as banks become increasingly reluctant to lend to one another, the role of central banks is evolving to acting as lender of first resort.