How do central banks work?

📘 In Brief Central banks control the money supply and interest rates of an economy. They set the key interest rate at which commercial banks can borrow money from them. This rate influences all other lending rates, such as those for mortgages or corporate loans. When the central bank lowers the key rate, money becomes cheaper, which stimulates investment and consumption. When it raises the rate, credit becomes more expensive, which curbs inflation and cools down the economy. Additionally, central banks manage the money supply through open market operations: they buy or sell government bonds. When they buy bonds, they inject fresh money into the market; when they sell, they withdraw money. In crises, they can also employ unconventional measures such as quantitative easing to push down long-term interest rates. Their primary goal is usually price stability, meaning low and stable inflation, often complemented by supporting the financial system. 🔍 Why This Matters Central banks control the money supply and interest rate conditions of an economy, primarily by setting the key interest rate at which commercial banks can borrow central bank money. Through this rate, they influence banks‘ lending to businesses and households, thereby dampening or stimulating consumption and investment. In addition, they use open market operations, buying or selling securities to directly increase or decrease liquidity in the banking system. In times of crisis, they can …