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Monetary Policy Fundamentals
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Interest Rate
The price at which borrowers can obtain capital. Central banks influence this rate to control economic activity; lower rates stimulate borrowing and spending, while higher rates tend to cool off the economy.
Open Market Operations (OMO)
The buying and selling of government securities in the open market by a central bank—a primary means of implementing monetary policy. OMOs influence the money supply and interest rates.
Reserve Requirement
The minimum amount of reserves that banks must hold against deposits. A lower reserve requirement increases the money supply, while a higher requirement decreases it.
Discount Rate
The interest rate charged to commercial banks and other depository institutions on loans they receive from their regional Federal Reserve Bank's lending facility—the discount window.
Quantitative Easing (QE)
A 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.
Inflation Targeting
A monetary policy strategy where the central bank aims to keep inflation around a specific target or within a certain range. Effective in anchoring inflation expectations.
Fisher Effect
The relationship described by Irving Fisher that states the real interest rate equals the nominal interest rate minus the expected inflation rate. It helps to understand how inflation affects saving and borrowing.
Liquidity Trap
A situation in which interest rates are low and savings rates are high, rendering monetary policy ineffective. In a liquidity trap, consumers choose to avoid bonds and keep funds in savings, despite the increase in the monetary base.
Monetary Base
The total amount of a currency that is either in general circulation in the hands of the public or in the commercial bank deposits held in the central bank's reserves. It's a measure of the money supply.
Taylor Rule
A principle that guides central banks on how to set short-term interest rates based on the economic conditions, stating that the interest rate should be adjusted according to the inflation rate and the output gap.
Zero Lower Bound (ZLB)
A macroeconomic problem that occurs when the short-term nominal interest rate is at or near zero, causing a liquidity trap and limiting the capacity of the central bank to stimulate economic growth.
Helicopter Money
An unconventional form of monetary policy that involves printing large sums of money and distributing it to the public in order to increase aggregate demand. Named after an analogy by the economist Milton Friedman.
Negative Interest Rate Policy (NIRP)
A controversial monetary policy tool where nominal target interest rates are set with a negative value, intended to encourage banks to lend more freely and stimulate economic growth.
Monetary Policy Committee (MPC)
A committee within a central bank that is responsible for setting key interest rates and controlling other aspects of monetary policy.
Forward Guidance
A central bank communication strategy in which the bank provides information about its future policy actions, intended to influence public expectations about future interest rates and inflation.
Currency Peg
The policy of fixing the exchange rate of a currency by matching its value to that of another single currency or to a basket of other currencies, or to another measure of value, like gold.
Policy Rate
The interest rate that the central bank sets to influence the evolution of financial and economic variables.
Neutral Interest Rate
A theoretical interest rate at which monetary policy is neither stimulative nor contractionary, and the economy is at full employment with stable prices.
Capital Requirements
Regulations that determine the minimum amount of capital a bank or financial institution must hold, as a safety precaution to prevent bank failure.
Interest on Excess Reserves (IOER)
The practice where central banks pay interest on the reserves banks hold beyond the legal reserve requirement. It serves as a monetary policy tool to help control interest rates and inflation.
Macroprudential Policy
A type of policy designed to mitigate financial system risks and ensure system stability. Often involves regulatory measures to prevent credit bubbles and manage financial booms and busts.
Seigniorage
The profit made by a government by issuing currency, especially the difference between the face value of coins and their production costs.
Discount Window
A central bank lending facility meant to help banks manage short-term liquidity needs by providing them with loans and charging the discount rate.
Nominal Anchor
A variable, such as an inflation rate or a money supply target, that a monetary authority uses to tie down the price level to achieve price stability.
Moral Suasion
A strategy used by central banks to influence and pressure, but not force, banks into adhering to policy. It can refer to both formal requests and informally persuading market behavior.
Overnight Rate
The interest rate at which banks lend money to each other for overnight loans. Central banks often target the overnight rate as a key monetary policy tool.
Tight Monetary Policy
A form of monetary policy that makes it more expensive to borrow (by raising interest rates) as a means of controlling inflation.
Loose Monetary Policy
A form of monetary policy aimed at stimulating economic growth by making it cheaper to borrow (through lowering interest rates) or by increasing the money supply.
Central Bank Independence
The condition in which a central bank operates without political pressure, allowing it to set monetary policy purely to achieve economic objectives such as controlling inflation and maintaining currency stability.
Yield Curve Control
A monetary policy in which a central bank targets certain yields on government bonds and buys or sells as many bonds as needed to reach that target rate.
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