Monetary policy is the process by which central banks — such as the US Federal Reserve, European Central Bank, and Bank of England — control the money supply and interest rates to achieve macroeconomic goals like price stability, full employment, and economic growth. Read more
Who controls interest rate?
EasyThe Central Bank of a country (such as the Federal Reserve in the United States) is the authority responsible for controlling interest rates. By raising or lowering the "benchmark" interest rate, the central bank can influence how much it costs for people to borrow money for cars and homes, and for businesses to borrow for expansion, thereby controlling the overall speed of the economy.
Interest rates have not always been positive; in recent years, some central banks in Europe and Japan have used "negative interest rates," which effectively means the bank pays the borrower and charges the person who is saving money!
What is 'Real Interest Rate'?
HardThe Real Interest Rate is the interest rate that has been adjusted to remove the effects of inflation. It represents the "real" cost of borrowing and the "real" return on savings. (Formula: Real Rate = Nominal Rate - Inflation).
If your savings account pays 5% interest but inflation is 6%, your "Real Interest Rate" is actually -1%, meaning you are losing purchasing power!
Which bank is known as the 'Lender of Last Resort'?
MediumA Central Bank (like the Federal Reserve or the Bank of England) is known as the "Lender of Last Resort." This means they provide emergency loans to banks and other financial institutions that are facing a liquidity crisis to prevent a total collapse of the banking system.
The concept was famously developed by Walter Bagehot in his 1873 book 'Lombard Street', which still guides central bankers today!
What is 'Seigniorage'?
HardSeigniorage is the difference between the face value of money, such as a 10 bill or a quarter, and the cost to produce it. For example, if it costs 5 cents to make a 1 bill, the government earns 95 cents in seigniorage.
If the cost of the metal in a coin becomes more than its face value (like some old pennies), the seigniorage becomes negative, and the government actually loses money by making it!
What is liquidity trap?
HardA Liquidity Trap is a situation in which interest rates are very low and savings rates are high, rendering monetary policy ineffective. In this state, consumers and investors prefer to hold onto cash (liquidity) rather than investing it, even when the central bank tries to stimulate the economy by increasing the money supply. This often happens when people expect a deflationary event or a war.
The concept was famously introduced by John Maynard Keynes; during a liquidity trap, the central bank's usual tool of lowering interest rates is like "pushing on a string"-it simply has no effect on stimulating the economy.
Who is the current head of the Federal Reserve (as of 2023)?
MediumJerome Powell is the current Chair of the Federal Reserve (the "Fed"), the central bank of the United States. He took office in 2018 and has led the U.S. through major economic events, including the COVID-19 pandemic and the subsequent period of high inflation.
Powell is the first Fed chair since the 1970s who does not hold a Ph.D. in Economics; he is actually a trained lawyer!
What is 'Quantitative Easing'?
HardQuantitative Easing (QE) is a form of monetary policy in which a central bank, like the Federal Reserve, purchases large amounts of financial assets (like government bonds) from the open market in order to increase the money supply and encourage lending and investment.
QE is often described as "printing money," though the central bank actually does it by creating digital credits in the accounts of commercial banks!
What is the main objective of a central bank?
MediumThe main objective of a central bank (like the Federal Reserve in the US or the ECB in Europe) is to maintain price stability, usually by controlling inflation. Most central banks also have a secondary goal of maintaining high employment and sustainable economic growth.
Central banks are often called "Lenders of Last Resort" because they provide emergency loans to banks during financial crises to prevent the entire system from crashing!
What is 'Liquidity'?
MediumLiquidity describes the degree to which an asset or security can be quickly bought or sold in the market without affecting the asset's price. Cash is the most liquid asset, while real estate or rare art is considered "illiquid."
During the 2008 financial crisis, many banks failed not because they were poor, but because their assets were "illiquid"-they had value, but they couldn't turn them into cash fast enough to pay their bills!
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