Every country has a central bank that will help control the economics of the country. They implement economic policies designed for the smooth operation of the country. Many investors wonder how and why the government gets involved in economic affairs, so you should know the answers to these questions if you intend trading in the markets, and particularly if you are going to use forex news in your trading strategy.
In the US, the central bank aims to maintain high levels of employment, price stability, promote sustainable growth and preserve the dollar’s purchasing power. It also aims to maintain long-term interest rates. Central banks are there to promote a strong economy and a solid banking system. These are not only the tasks for the US central bank, but for all central banks worldwide.
Forex News and Monetary Policy
Monetary policy refers to the measures that a central bank takes to influence the level of credit available and the amounts of money available in the economy. Any changes to the amounts of credit and money available will affect the cost of credit. This means that if interest rates are reduced, more individuals and companies will borrow money which will boost the economy.
The Methods They Employ
Central banks have specific tools at their disposal to maintain the monetary policy.
The Discount Rate
The discount rate is the rate that the central bank charges banks on its short-term loans. This rate is normally lower than the bank funds rate, although they are linked. This rate holds importance as it indicates an adjustment in the central bank’s monetary policy. This movement allows forex traders a bit of insight into the direction of the central bank’s monetary plans.
Central banks often buy and sell securities in the open market. This is a means of adjusting the reserves that are held in the banking system. The decisions made in this regard affect the interest rates. Open market indicates that the central bank has no control over which dealers it will deal with on a particular day. It chooses an open market where primary securities dealers operate. This is the most commonly used tool related to monetary policy.
This is the level of physical funds banks need to hold in reserve, in line with the deposits held in the bank accounts of their clients. It sets the level at which banks can earn via investments and loans. This reserve requirement which is usually set by the Board of Governors is normally about 10%, but it does vary at times. This indicates that a bank may be able to hold 10 billion in deposits, but since the bank generally lends out most of the funds, it does not necessarily hold the full amount of 10 billion in its hands. It would be quite costly and difficult for a bank to hold that much money in bills and coins within its building. Therefore, the excess reserves are either held in vaults or it is held in the bank’s central bank account. It is however necessary for the depository institution to hold a minimum level of physical cash in their reserve.
Central banks generally hold more power, as well as influence in the financial markets, than any other government department. As a trader, you should keep up to date regarding forex news and the central bank policies.
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