Central banks implement a country's chosen monetary policy. At the most basic level, this involves establishing what form of currency the country may have, whether a fiat currency, gold-backed currency, currency board or a currency union. When a country has its own national currency, this involves the issue of some form of tandardized currency, which is essentially a form of promissory note: a promise to exchange the note for "money" under certain circumstances. Historically, this was often a promise to exchange the money for precious metals in some fixed amount. Now, when many currencies are fiat money, the "promise to pay" consists of nothing more than a promise to pay the same sum in the same currency.
Many central banks are "banks" in the sense that they hold assets (foreign exchange, gold, and other financial assets) and liabilities. A central bank's primary liabilities are the currency outstanding, and these liabilities are backed by the assets the bank owns. Unusually, however, central banks in jurisdictions with fiat currencies may "create" new money to back its own liabilities, to theoretically unlimited amounts. In many countries, the central bank may use another country's currency either directly (in a currency union), or indirectly, by using a currency board. In the latter case, local currency is directly backed by the central bank's holdings of a foreign currency in a fixed-ratio; this mechanism is used, notably, in Hong Kong and Estonia. In countries with fiat money, monetary policy may be used as a shorthand form for the interest rate targets and other active measures undertaken by the monetary authority.
Many central banks are "banks" in the sense that they hold assets (foreign exchange, gold, and other financial assets) and liabilities. A central bank's primary liabilities are the currency outstanding, and these liabilities are backed by the assets the bank owns. Unusually, however, central banks in jurisdictions with fiat currencies may "create" new money to back its own liabilities, to theoretically unlimited amounts. In many countries, the central bank may use another country's currency either directly (in a currency union), or indirectly, by using a currency board. In the latter case, local currency is directly backed by the central bank's holdings of a foreign currency in a fixed-ratio; this mechanism is used, notably, in Hong Kong and Estonia. In countries with fiat money, monetary policy may be used as a shorthand form for the interest rate targets and other active measures undertaken by the monetary authority.
