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Posted by on Aug 12, 2016 in Central Bank, Finance, Policy Instruments |

Central Bank – Policy instruments in its hands

Central Bank – Policy instruments in its hands

In the majority of the democratic countries, a central bank is free from the political influence and due to that it wields a lot of power. Freed from the clutches of different political parties the central bank has many financial instruments with which they maintain the healthy monetary policy. Some of these tools are visible, but some can’t be seen, and they influence the monetary policy from the shadows.


Content goes here The Central Bank uses open market operations to pump more money into the economy. This entity can buy bonds on the market, and they pay for those bonds with the newly printed money. These operations can also work as a means for lowering of a particular security. If the amount of money is too large, the bank can sell the securities it owns and in effect reduce the money supply. The central bank can give a short-term boost of money to the market through temporary loans for collateral securities (this short term money increase may last from a week to a month).

Exchange requirements represent the ability of the bank to enforce the rule that all foreign receipts must be exchanged for the primary currency of the country. The rate of the purchase of that currency is, in most cases, based on the market (in some cases the bank sets the price). The bank can also limit the use of the currency in the hand of the recipient. They can set a time limit within which the money can’t be traded for other currencies and similarly enforced boundaries.

Capital requirements represent the universal law that every bank needs to have a certain percentage of their assets in capital. The height of the rate is in the hands of the central bank. Every bank that operates in a country, domestic or international branch, has to respect the rate set by the monetary authority of the same country. Capital requirements are far more useful in the prevention of indefinite lending than the reserve requirements that exists solely for that. The high effectiveness of the capital requirements comes down to the law of threshold. This rule (law) states that a bank can’t provide loans if it doesn’t have enough capital in its reserve. If it wants to continue with their lending, they have to acquire more money.

The interest rate is an obvious and the most powerful instrument of the central bank. The interest rate is never fixed; it goes up and down depending on the various influences. An explicit (target) interest rate always exists, and this monetary authority borrows and lends money to keep the rate as close to that target as possible. The target rate changes depending on the requirements of the economy within the country.

The Central bank doesn’t keep the interest rate on the target at all possible times. That would mean constant money investments which would weaken the currency. As always, this entity has to balance various demands and use their instruments in the best possible way. For example, if the central bank focuses on the inflation, the interest rate may move freely in any direction.

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