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Central banks act as regulatory systems of financial institutions of any given country. One of the significant functions of central banks is to regulate currency valuation and devaluation. If a country is experiencing a downward valuation trend in its currency, the central bank may intervene to control the devaluation trend. Devaluation usually occurs when there is excessive cash flow of a given country in the foreign exchange market (Devaluation-Money.). This can be a result of other countries disposing the said currency into the market. The effect of this action is to devalue the currency leading to inflationary trends.
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The central bank buys its own currency in an effort to regulate and control the currency’s value. Once it buys back its own currency, it strengthens its currency. The central banks may opt to buy other country’s currency in an effort to peg its currency against it. This action adds value to its own currency.
During the financial crisis in the period of 2007 to 2009, the centra banks had to lend money to financial institutions to avail them with liquidity. The crisis had the effect of causing massive losses. The financial institutions found it to be difficult to meet their liquidity requirements. Since all the financial institutions at the time were experiencing this problem; the central banks as a last resort for borrowing purposes had to step in to control the crisis. They had to lend and inject money to other financial institutions.
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The central banks in Europe and the United Kingdom had to result in reducing their lending interest rates. The central banks opted to increase their balance sheets by acquiring assets and providing liquidity to other financial institutions. The United Kingdom injected money equivalent to 1.6 percent of GDP. The European central banks had to inject an average of 2 percent of the GDP into the economy whereas the central bank of china injected over 3 percent of the GDP into the economy (President's Economic Report, 2010)
The efforts of the central banks in mitigating the effects of the financial difficulties allowed the control of losses that the economies were experiencing during this period. This was by regulating the inflationary effects arising as a result of the crisis. The effects were significantly positive, and the crisis began to abate at the same time realizing growth in the respective economies. The central banks measure of other financial institutions credit limits and their ability to function and operate efficiently was a critical determinant in establishing the extent of the injections to those financial institutions (Acharya, Phillipon, Richardson & Nourlel).
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The same criteria were in implementation by the United States central bank and Federal Reserve. They were lending massive quantities of money to other central banks and other financial institutions. The actions of the central banks prove to be effective. Their actions made the effects of the crisis abate significantly preventing the collapse of significant institutions and economies.
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