Central Bank – Demystifying Monetary Policy

Central Bank’s Monetary Policy

Traders need to understand how a central bank’s monetary policy is

  1. Determined
  2. Implemented

Why? Because central banks like the Federal Reserve Bank, Bank of England, Reserve Bank of Australia use monetary policy tools to influence the direction of interest rates. Central banks across the world attempt to influence short term and long term interest rates through their monetary policy. Interest rates, in turn, impact financial asset prices such as bonds, stocks, and forex.

Traders, therefore, need to understand the two key aspects of the monetary policy cycle – its determination and its implementation. Since central banks determine their monetary policy based on economic indicators that provide clues on the direction of growth and inflation, market participants also track these indicators to predict the central bank’s next move. These indicators are covered in another section – Fundamental analysis of the markets

Demystifying Federal Reserve’s Monetary Policy

To understand the central bank monetary policy we will begin with the basics. We will focus on understanding the Federal Reserve Bank’s monetary policy as other central banks worldwide track the Federal Reserve Bank’s monetary policy very closely. Financial market participants across the world watch the Fed’s every move to gain insights on when the Fed will shift their policy stance.

A Central bank has two methods to influence the economy – influencing key interest rates and the power to create money. Through monetary policies, central banks greatly influence forex markets, commodity markets, bond yields, mortgage rates and also economic factors such as growth and inflation.

The Roadmap

By the end of this topic you will possess the complete knowledge on how central bank’s determine and implement the monetary policy, including topics such as fractional reserve banking, asset liability management, liquidity management, money, fed funds rate, discount rates, repos and how it uses these tools to bring about changes in the economy and asset prices.

Banking Basics – Assets, Liabilities, ALM, Liquidity Management

Begin with the basics of banking, especially a bank’s assets, liabilities, liquidity management, reserves, asset-liability management, fed funds and more to build a strong foundation from which we can move to more advanced topics of the fed funds market, discount windows and more.

The flow of Funds or Financial Accounts of the United States

Next, we study the flow of funds accounts formally known as the Financial Accounts of the United States. This account provides us details on the sources and uses of funds in the US economy. Why you need to understand this account is well explained in the section – Flow of Funds Overview.

Money Supply, Money, Monetary Aggregates

Once we understand the impact of the flow of funds on interest rates and exchange rates we will understand the basic concepts of money.

infograph Federal Reserve Bank

Monetary Policy Federal Reserve Bank


Related Topics

Flow of Funds

Banking Basics

Trading on Economic Indicators

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