Central banks move interest rates to keep prices steady. They buy or sell securities, and that pushes short-term rates up or down.
The aim is steady prices
The IMF says central banks use monetary policy to manage economic ups and downs. Their main goal is price stability, which means inflation that is low and stable. Many advanced economies set a clear inflation target. Many developing countries are moving that way too.
How the dial turns
Central banks adjust the supply of money, usually by buying or selling securities in the open market. These open market operations affect short-term interest rates. Those rates then influence longer-term rates and economic activity.
When a central bank lowers rates, the IMF calls it easing. When it raises them, that is tightening.
After the 2007 crisis
Advanced economies cut rates until short-term rates were close to zero. That left little room for more cuts. Some central banks bought long-term bonds to push long-term rates lower. Some even took short-term rates below zero.
The COVID-19 pandemic brought more easing and support for credit. Many emerging market central banks stepped into currency and bond markets as well.
The turn to tightening
More recently, central banks around the world raised interest rates because inflation was growing rapidly. The IMF notes that some major central banks have since made small cuts, as inflation fell from its recent highs.
Rates and the value of a currency
A country’s interest rates affect the value of its currency. So a country with a fixed exchange rate has less freedom to set its own course than one with a flexible rate. The IMF says a fully flexible exchange rate supports an effective inflation-targeting system.
A wider job
The 2007 to 2009 crisis showed that countries must spot and contain risks to the whole financial system. Many central banks now do this through what the IMF calls macroprudential policy. It says they suit the job because they can study risks across the system. They are also often fairly independent, which helps them resist political pressure.
