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Central Banking 101

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Central Bank Independence

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A situation where the central bank operates without political interference, primarily to ensure that monetary policy decisions are made to achieve long-term economic goals and not for political reasons.

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Inflation

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The rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling.

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Taylor Rule

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A monetary policy rule that stipulates how much a central bank should change the nominal interest rate in response to divergences of actual inflation rates from target inflation rates and of actual GDP from potential GDP.

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Interest Rate

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The amount charged by a lender to a borrower for the use of assets, expressed as a percentage of the principal.

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Reserve Requirement

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The minimum amount of funds that a commercial bank must hold in reserve against customer deposits.

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Policy Rate

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The interest rate that a central bank charges on its loans to commercial banks. It is often used as a benchmark to guide other interest rates in the economy.

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Discount Rate

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The interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility.

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Open Market Operations

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Activities by a central bank to buy or sell government bonds on the open market to influence the quantity of money and the level of interest rates.

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Monetary Policy

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The process by which a central bank controls the supply of money in an economy, primarily through interest rates.

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Lender of Last Resort

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The role of a central bank to provide loans to banks or financial institutions that are experiencing financial difficulty or are considered highly risky or near collapse.

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Dual Mandate

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The responsibility of a central bank to ensure price stability while also pursuing full employment, which is particularly associated with the U.S. Federal Reserve.

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Fiat Money

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Currency that a government has declared to be legal tender, but it is not backed by a physical commodity and has value only because of a government's decree.

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Quantitative Easing

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An unconventional monetary policy in which a central bank purchases government securities or other securities from the market to lower interest rates and increase the money supply.

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Balance Sheet Expansion

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The increase in a central bank's assets due to the purchase of long-term securities to inject money into the banking system and promote increased lending and liquidity.

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Bank Supervision

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The examination and oversight of financial institutions to ensure that they are operating safely and soundly and in compliance with laws and regulations.

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