Central banks and monetary policy Research Paper - 1

Central banks and monetary policy - Research Paper Example The main purpose of a central bank is, briefly, to supervise a nation's currency. This is attained by setting monetary policy. Following are the five important objectives of central banks; Price Stability: The main objective of a central bank is price stability, or in other words, a stable and low rate of inflation. â€Å"Price stability is defined as a year-on-year increase in the Harmonized Index of Consumer Prices (HICP) for the euro area of below 2%.The Governing Council has also clarified that, in the pursuit of price stability, it aims to maintain inflation rates below, but close to, 2% over the medium term† (The Definition of Price Stability n.d para 2). Conversely, the existing view between economists is that in the long run, given that inflation is stable and low, monetary policy only influences nominal aggregates, for instance inflation, the nominal exchange rate and nominal interest rates, and not only their long-term development levels in actual terms. In the long run monetary policy consequently controls its monetary value, which are general prices. Real Stable Growth: In the banking system of urbanized countries there is a stable connection between various interest rates. The lowest price is the one charged to banks by the central bank. â€Å"This rate is normally 1-2.5 percent higher than the rate of inflation, depending on the monetary policy stance.† (Trade and Development Report 2008 by United Nations Conference On Trade and Development 2008). In actual terms, all these rates stay close to the actual growth rate of the financial system. One of the most significant circumstances for successful growth is the growth of various sectors including, the financial sector, which cannot deviate enduringly from the growth of price added of the financial system as a whole. Financial Stability: Financial stability illustrates the situation where the financial intermediation method functions easily, and where there is assurance in the operatio n of important financial organizations and markets within the financial system. Central banks have traditionally played an important role in the management of economic crises, lending to solvent, other than illiquid organizations as a last resort, still if this role has rarely been buttressed or formalized by legal authorities. Central banks consequently have objectives that are reliable with a leading role in a special resolution regime. They can also organize tools that are already in their area (LOLR) to maintain financial stability. They can, additionally, draw on expertise in the study of financial stability, containing the significant ability to measure the crash in markets, payment methods, and the financial communications at large. Interest Rate Stability: Interest rates provide global savers a reason to transfer money from one country to another in search of the safest and the highest yields. The central bank must support interest rate stability in short term and long term maturities. The short term rates are simple enough to understand that a central bank controls the discount rate, and that it can strongly target the federal funds price. Long term rates can be straightly targeted by central banks, other than that the latter typically favor to let financial market participants perform the job and not to affect them directly by credible policies.