Editing Central bank (section)

====Monetary policy instruments====

The primary monetary policy tool available to central banks is the administered interest rate paid on qualifying deposits held with them. Adjusting this rate up or down influences the rate commercial banks pay on their own customer deposits, which in turn influences the rate that commercial banks charge customers for loans.

A central bank affects the monetary base through [[open market operations]], if its country has a well developed market for its government bonds. This entails managing the quantity of money in circulation through the buying and selling of various financial instruments, such as treasury bills, repurchase agreements or "repos", company bonds, or foreign currencies, in exchange for money on deposit at the central bank. Those deposits are convertible to currency, so all of these purchases or sales result in more or less base currency entering or leaving market circulation.

If the central bank wishes to decrease interest rates, it reduces its administered rates ([[Bank rate|Bank Rate]], the [[Repurchase agreement|reverse repurchase agreement rate]] and the [[Discount window|discount rate]]). This results in commercial banks bidding down the rate they pay customers on their deposits and, subsequently, loan rates are reduced commensurately. Cheaper credit can increase [[consumer spending]] or business investment, stimulating output growth. On the other hand, cheaper interest income can reduce spending, suppressing output. Additionally, when business loans are more affordable, companies can expand to keep up with consumer demand. They ultimately hire more workers, whose incomes increase, which in its turn also increases the demand. This method is usually enough to stimulate demand and drive economic growth to a higher rate. In other instances, monetary policy might instead entail the targeting of a specific exchange rate relative to some foreign currency or else relative to gold. For example, in the case of the [[United States]], the [[Federal Reserve]] targets the [[federal funds rate]], the rate at which member banks lend to one another overnight; however, the [[monetary policy of China]] (since 2014) is to target the exchange rate between the Chinese renminbi and a basket of foreign currencies.

A third alternative is to change [[reserve requirements]]. The reserve requirement refers to the proportion of total liabilities that banks must keep on hand overnight, either in its vaults or at the central bank. Banks only maintain a small portion of their assets as cash available for immediate withdrawal; the rest is invested in illiquid assets like mortgages and loans. Lowering the reserve requirement frees up funds for banks to buy other profitable assets. However, even though this tool immediately increases liquidity, central banks rarely change the reserve requirement because doing so frequently adds uncertainty to banks' planning. Most modern central banks now have zero formal reserve requirement.