Central Bank Responsibilities & Its Effects On The Forex Market
January 14, 2023
Central Banks are very important for any country’s economy, they are responsible for managing different aspects of the economy.
If you are interested in knowing about central bank responsibilities and their effects on the Forex market, we highly recommend you to read this article on the Aron Groups Broker website.
Table of Contents
What Is a Central Bank?
A central bank is the most important bank in a country that is responsible for liquidity management, also managing banks.
Central Bank decisions are very important and affect the whole economy, all people must be aware of these decisions and this is especially important for investors and traders alike.
- Federal Reserve is the most important central bank in the world, this entity is the central bank of the United States of America
- There are different aspects that a central bank should manage and we will speak about them in the next section of this article
Here we want to emphasize the importance of central banks and being aware of their functionalities as a trader or investors.
Do you know about the central bank’s responsibilities?
Central Banks Responsibilities
All countries have central banks, this is the most important bank of the country and one of the most important entities for governance inside a country.
We will explore the different responsibilities of a central bank, then in the next section, we will introduce you to the effects of the central bank decisions on the Forex market.
1. Managing Interest Rate
One of the most important tasks of the central banks is managing the interest rate, this is an overnight interest rate banks lending to each other.
- The central bank of the country determines the interest rate and changes it based on the economic condition of the country
- If the country has a high inflation rate, this is the time in which central bank increases the interest rate to combat the high inflation rate
- Also, when there is a need to increase the economic growth rate, then the central bank decreases the interest rate to grow the demand and help the economy to recover and grow
Interest rate is a very important factor that the central bank controls.
A high-interest rate means it’s harder for people to borrow because the interest rate is higher than ever.
While at a low-interest rate, borrowing is cheaper and people will borrow more, demand keeps rising, and this will increase the production level of the county.
2. Management Of Inflation Rate
The inflation rate is a very important topic, the high inflation rate is very dangerous, and can make life difficult for society.
At the same time, a very low or negative inflation rate is also harmful as it will decrease the incentive for production and growth inside an economy.
- The central bank has two tools for managing the inflation rate, the first one is changing the interest rate which is the overnight rate among the banks
- And the other tool is printing money or increasing liquidity which can include purchasing government and companies bonds to help them or selling bonds for decreasing the liquidity
By using the interest rate and liquidity, a central bank can manage the inflation rate for an economy and keep it at the best level appropriate for both producers and consumers which is usually between 2% to 3%.
3. Unemployment Rate Management
The unemployment rate is one of the indicators used for being aware of economic healthiness.
- There are multiple tools that a central bank can use to manage the county’s unemployment rate
- The first tool is the interest rate, raising it will increase the unemployment rate at the cost of managing the inflation rate, and lowering it will increase the economic growth rate and decrease the unemployment rate
- The other tool that a central bank can use to manage the unemployment rate is liquidity, central bank can increase the liquidity of the government or companies to lower the unemployment rate
- Also, a central bank can ease the management laws for banks, letting them use their resources for lending and offering more loans to people and banks, this can combat against high inflation rate, and decrease the unemployment rate
All of these three tools are available for the central bank to manage the unemployment rate as a high unemployment rate is very dangerous for the economy, and can have serious consequences for the economy and society.
4. Managing Economic Growth Rate
An economic growth rate means increasing the production level of a country or an economy.
- Central banks can use the interest rate to manage the economic growth rate, avoid recession, also avoid overheating
- Also, central banks can use banks, liquidity, and loans as tools for managing the economic growth rate of the economy
A healthy economy has a very good growth rate while also with a managed inflation rate, and a central bank has a key role in this space.
5. Determining Legal Reservations Of The Banks
Banks should put part of their assets inside the central bank of the county to manage their risks, this is a very important topic in the banking industry.
- Legal reservation is varied and is determined by the central bank
- Usually, this rate is between 10% to 15% of the bank’s total assets, a lower rate means more capital for the banks, and a higher rate means less capital for the banks and a tough situation
The central bank has this powerful tool to manage banks, and increase/decrease the liquidity of the banks and society based on the economic condition of the country.
6. Controlling Bank’s Balance Sheets
One of the most important topics in the economy and finance is the balance sheet of the banks.
- A Balance Sheet is a paper showing the total assets, total debt, and total net worth of an entity
- Central banks can manage the different bank’s balance sheets, and make appropriate decisions based on each bank’s condition and the rules that a country has in this space
Banks are very important institutions in the economy, and any serious changes in their balance sheets can have effects on the whole economy.
7. Printing Money
Printing money is one of the responsibilities of the central banks, this helps them to recover the old money and pump fresh money into the economy.
The central bank is the only entity that has this right to print money, and based on the economic condition will use this power.
8. Liquidity Management
Liquidity is a very important topic in finance, central banks by changing interest rates, and buying/selling bonds can manage the liquidity of the economy.
Also, banks are very important in this space, and central banks by managing banks’ legal reservations and balance sheets can manage liquidity.
9. Gold Reserves
Gold has been important since ancient days, and in today’s world, central banks are the places where a country manages its gold reserves.
- Gold is very important and expensive, and more gold means more wealth for the country
- Also, golds are very important for society, and the central bank can manage the amount of gold available in the economy
10. Currencies Reserves
The last most important central bank responsibility that we want to speak about is the topic of currency reserves.
- Central Banks are places where different currencies of different countries are kept using in the economy
- The most important currencies that central banks have and keep are the US dollar and the Euro.
Now, you are aware of the most important central bank’s responsibilities, we want to speak about the central bank’s effects on the Forex market.
Central Banks’ Effects On The Forex Market
As you may know, the Forex market is the biggest financial market in the world and is an online place for exchanging different currencies together.
There are many players in this market, from central banks to governments, companies, banks, and individual traders.
- Central banks’ decisions about changing the interest rate of their economies can change their national currencies’ value
- Also, central banks’ decisions for managing the economic growth rate, unemployment rate, and inflation rate can change the value of their national currencies
One thing is very important to know and that is about the Federal Reserve, the United States of America’s central bank, as the US economy is the biggest in the world, Federal Reserve decisions have a global effect, and this must be considered for successful trading or investing in the Forex market or different capital and financial markets.
The Final Thoughts
Central banks are one of the most important entities for any economy, and being aware of their responsibilities and decisions is highly important for traders and investors.
We introduced you to the most important central bank’s responsibilities and its effects on the Forex market in this article by the Aron Groups Broker.
Should you have any questions about central banks or trading in the Forex market using the Aron Groups Broker, contact our customer service team using the phone numbers available on the website.
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