The European Central Bank (ECB) recently shed light on the sources of central bank profits and losses, underscoring that the primary mandate of a central bank is to maintain price stability, rather than to generate profit.
This explanation was part of a podcast released on February 23, 2023, following the publication of the ECB’s financial statement for the year ending 2022.
The podcast stressed the importance of central banks focusing on their core mission of keeping prices low and stable, even if it means incurring losses.
“In today’s difficult economic environment, central banks across the world are either making or warning of losses. It’s important to remember though that central banks are not like ordinary companies; they can lose money and still operate effectively,” the podcast stated.
Although the discussion centered on the context of the ECB and the central banks in the 20 countries using the Euro, it provided valuable insights into how and why central banks globally incur losses. “A central bank doesn’t work towards making a profit. Its mandate is actually to keep prices stable,” the podcast revealed.
The ECB clarified that, unlike ordinary companies, central banks’ primary objective is not to make profits or avoid losses at all costs. “We are a public institution and like an ordinary company, we can make profits and losses, but making profits or avoiding losses at all costs is not our aim. Our aim is to keep prices stable,” the podcast explained, further stressing that profit is “basically a by-product of what we do, of our mandate.”
Analyzing the composition of costs to the ECB, the podcast highlighted that a significant source of costs is the interest paid on deposits from commercial banks. “When banks deposit money with us, and banks do deposit money with us because they have accounts with us just like citizens have accounts with commercial banks, commercial banks have accounts with the Euro system and we pay interest rates on these deposits and that’s, I would say, the biggest source of costs.”
The ECB sets three key interest rates, including the deposit facility rate, which determines the interest paid to banks on their deposits. This is analogous to the cost of open market operations used by some central banks to manage excess liquidity in the economy.
“These losses that we’ve seen this year have been down to different things, some of them a little bit more tricky to explain than others, but this last point that we talked about, the interest rates, this is key here because they’re closely linked to some of those losses. I just want to zoom out a second to look at the economic environment that we’re in right now because it’s also important. Inflation is high and we are raising our key interest rates to tackle that including the deposit facility,” the ECB explained.
Reflecting on similar scenarios, the Bank of Ghana recently released its Annual Report and Financial Statements, revealing a cost of GH¢8.3 billion on its open market operations aimed at curbing inflation. This substantial cost has significantly contributed to reducing inflation from 54.1% at the end of December 2022 to 23.2% by the end of December 2023.
The Bank of Ghana emphasized that maintaining low and stable inflation is a prerequisite for economic growth and that within a floating exchange rate regime, it also contributes to exchange rate stability. The Bank of Ghana’s medium-term inflation target is 8%, with an acceptable fluctuation range of plus or minus 2% of this target.