What’s The Role Of Central Banks In Monetary Policy Decisions?

Each country has official institutions aimed at maintaining its financial stability and preserving the value of the local currency. These financial authority institutions are called central banks. With the policies of central banks, countries aim to maintain their financial stability according to their special conditions.

Central banks are the main institutions where a country’s monetary policy strategies are determined. By determining the most appropriate monetary policy strategies according to the current situation of the countries, they manage the supply-demand balance of the local currency in accordance with financial expectations.

Central banks are the most effective management unit in monetary policy decisions. Depending on the geopolitical and financial situation of the country, moves are made by central banks to ensure financial stability, control inflation, reduce unemployment rates and, as a result, ensure financial development.

How Do Central Banks Influence The Economy Through Monetary Policy?

The biggest factor in a country’s financial health is central bank decisions and policies. Statistics such as production-consumption rates, import-export ratios, gross national gross product in a country allow us to get an idea about the financial health of that country. However, all these factors must be combined with the right policies proposed by central banks.

Otherwise, there will be problems with issues such as inflation and unemployment. Monetary policy decisions proposed on a scientific basis, independent of political pressures and geopolitical developments, will be more beneficial for the financial stability of the country.

Among these decisions, the most important ones are interest rates. Central banks regulate the country’s borrowing costs by determining interest rates on an annual basis. When central banks set higher interest rates, there is a decrease in consumption and investment rates, whereas in other cases, there are large increases in both consumption and citizens’ turning to investment opportunities.

However, interest rates must be determined in accordance with the special expectations and demands of local conditions.

What Are The Key Tools and Mechanisms Central Banks Use For Policy Control?

Central banks use many tools and processes for policy control. The most common among these are determining interest rates more accurately with analysis tools, creating management staff consisting of people who are experts in the field of finance, making use of units that control the money supply, distributing resources to make banks’ loan packages flexible, and similar operations.

Different policies need to be offered in different economies. However, these are generally strategies commonly used by central banks to keep economic policies under control in the direction they want.

Central banks that are free from political pressures, receive help from fundamental and technical analysis tools, and are competently managed by staff consisting of experts in their fields will propose more beneficial monetary policies. The reason why the financial stability of developed countries is so successful and strong today is that their central banks have achieved this independence.

How Can Monetary Policy Impact Inflation, Interest Rates, And Economic Growth?

Monetary policies directly affect factors within a country’s financial health. Among these factors, there are important factors such as inflation, interest rates, import-export rates, production-consumption balance, credit options, foreign debts and gross national product. All of these are directly affected by the monetary policies of central banks as important elements on the path to economic growth.

When central banks raise interest rates for a new year, inflation is kept in check. This results in less consumption, reducing inflation rates and maintaining the value of the local currency. However, since this will slow down economic growth, the optimum interest rate must be determined by the central bank.

The ideal interest rate should be calculated by the central bank in order to keep inflation under control and to encourage people to choose consumption and investment options. At this stage, incorrect decisions due to political pressures or geopolitical developments will result in a market collapse or financial crisis, resulting in a decrease in the value of the local currency, as in many countries.

It should not be forgotten that the main task of central banks is to propose monetary policies that will ensure the preservation of the value of the local currency.

What Role Does The Independence Of Central Banks Play In Policy Effectiveness?

As I just mentioned, central banks that are not scientifically based and have lost their independence can cause great damage to financial stability by setting incorrect rates. If interest rates in a country are determined by political authorities under pressure, it becomes impossible to form realistic perspectives.

For this reason, central banks, with their staff consisting of expert financiers in their fields, should not be under the influence of the political power, and if possible, a common understanding should be developed and collaborations should be made. Otherwise, it will become difficult to fight inflation and financial stability will be shaken.

I should remind you that the central banks of the developed economies of today’s world, such as the USA and China, have independent control mechanisms. However, when the financial crises experienced by South American countries or other developing countries are examined, it is seen that the monetary policies of central banks are affected by political hegemonies and therefore negatively affect statistics such as inflation and unemployment.

Independent central banks are essential for financial growth and economic stability. If a central bank is managed independently and with a science-based approach, its short and long-term effects will be seen immediately in the market.

How Do International Monetary Policies Interact In The Global Economy?

Today’s digitalized banking ecosystems include members who interact more with each other. Among these countries, it created the global economic arena. For this reason, central bank decisions in a country cause global effects by affecting other countries with which it has commercial and political relations.

When the central bank in a country proposes monetary policies by increasing interest rates, this leads to direct international effects. There may be a direct decrease in the capital allocated to investment and consumption, and it may also pose a problem for commercial agreements. International financial communities are established to prevent such situations and prevent financial crises.

Communities such as the European Union, NATO and the United Nations work and develop common paths not only on social issues but also for the global world to establish healthier financial interaction with each other.

Countries that are independent of such global organizations and do not develop commercial and political relations with other countries experience financial shrinkage in the competitive modern economic world. For this reason, central banks need to be aware of global understandings and be managed with this perspective.

See you in the next post,

Anil UZUN