Central bank decisions are some of the most anticipated events in the financial markets. Known for controlling interest rates, their moves can ripple through the broader economy and your investing strategies. They may also influence your daily life. For example, when interest rates fall, it can lower your mortgage costs and the cost of financing consumer debts.
Central banks must strike a delicate balance between controlling inflation and strengthening the economy. They do this through the use of monetary policy, which involves increasing or decreasing short-term interest rates, which are the ‘price of money’. Inflation is when prices increase over time, and this can lead to a decline in real economic growth as consumers and businesses reduce spending and invest less.
The monetary policy committees (MPCs) of each country’s central bank have a wide range of tools at their disposal, and the specific procedures used by MPCs are often classified as secret. However, there is a general consensus that they operate under the legislated objective of contributing to employment stability, without jeopardizing their inflation target.
These goals are not always easy to accomplish. As a result, central banks must constantly explain their policies to the markets and the media, and be clear about why they are changing their course. Such consistency builds credibility over time, but it requires a long-term commitment that transcends the tenure of any particular leadership. It also requires a commitment to enduring pain in the short run, in order to avoid unforeseen consequences that would ultimately hurt more than help.