Background
The first central bank was Swedish Riksbank. The Swedish government chartered it to act as a clearinghouse for commerce. In 1694, the Bank of England was founded. It’s primary purpose was to purchase government debt. Napoleon chartered the Banque de France to stabilize currency after the French Revolution.
Early central banks, and their modern counterparts have many functions. One of the best-known is they issue currency and hold a monopoly over money. They also enable non-central banks to operate, issue other banks loans, purchase state debt, create money, and manage inflation.
Controversially, central government-chartered banks can become a lender of last resort during financial crises.
Purpose of central banks
One often misunderstood component is that central banks are private institutions, not unlike other banks. The difference is they enjoy monopoly powers other banks do not – including and especially the ability to issue currency – and their only customers are other banks. Their original customers are other banks. Their only product is short overnight loans. However, most notably during the Financial Crisis of 2007-2008, the US Federal Reserve loaned money directly to bail out banks and private businesses.
While central banks issue currency, most tied their currencies to gold. While the gold standard was abandoned during the 20th century, many central banks still have vast amount of gold. The US Federal Reserve has over 400 tons of gold in the vault under its bank in New York City.
Nevertheless, many central banks print currency tied to nothing, called fiat currency. Other central banks tie their currencies to other fiat currencies or a combination of fiat currencies.
Countries have gone without central banks, but it usually does not end well. The US had an 80-year period with no central bank: states made their own banks which issued their own currency. There were bank runs, massive fraud, and payments took forever to clear as the various individual banks worried about fraud. A financial crisis in 1907 convinced the US government of the need for one central bank and, in 1913, the Federal Reserve was created.
Modern central banks
During the 20th century, central banks added overall economic health to their focus. Before then, their primary goal was to make sure the money supply was stable and ensure payments between banks. They evolved and, today, central banks also try to reduce unemployment and prevent recessions.
The heads of most central banks are economists.