Lesson 2. The Central Bank

Each country has it’s own Central bank with the exception of Country’s in the EU whom are governed by the ECB (European Central Bank). The Central Bank has 3 objectives. 1. High Employment, 2. Growth 3. Manage Inflation (2% per year) . It does this by increasing the supply of money in times of recession to encourage spending and decreasing supply in times of growth, to reign in spending. It has 3 tools to do this. 1: Interest Rates: It can raise or lower its interest rate to make its currency cost more or less to borrow. A low IR makes borrowing it cheap, so there's plenty of supply in the economy.  While a high IR makes money expensive (a luxury) so there will be far less supply. 2: It can set the minimum amount of cash retail banks must hold in their bank vaults, this is called the Reserve Requirement. This essentially dictates to "barclays" how much they can loan out. A low reserve requirement means they can make lots of loans, increasing the supply of money in the economy. A high reserve requirement means they can only loan out a limited amount of money, decreasing the supply. Tool 3: Open Market Operations (buying bonds): Sounds terrifying but is the easiest to understand. In this scenario the Central bank enters the market place and loans money to either businesses or the government, injecting cash into the economy. Of course it is a little harder to get the money back because it all depends on when the borrower can pay it back ;). So it's not so good at reducing supply! The basic concept is this... If the central bank is lowering interest rates & reserve requirements and buying lots of debt, it is making money affordable, to try to stimulate the economy. If it is raising interest rates and reserve requirements, it is making money expensive, to try to cool an overheated economy where the price of basic necessities are so inflated the poor are struggling to afford them. If you can get this you're well on your way.