As we mentioned in a previous article, central banks have a few tools at their disposal to try to support an economy when it is in a fragile state.
One is QE, a more aggressive tool used as a last resort. The other, the one we will talk about in this article, is the central interest rate.
What are central bank interest rates
Central interest rates, or benchmark interest rates, are the interest rates that the Central Banks of each country impose on the banks operating in their area of influence. This means that whenever a bank or financial institution needs to borrow more money or simply deposit some of its capital, it will have to do this with its Central Bank and pay the appropriate interest.
It is also important to know the two main types of interest rates:
- Refinancing interest rate – This is the rate of the cost of credit that the Central Bank makes its loans available to banks.
- Deposit interest rate – Just like us, banks need to deposit their capital, and to do this they use their Central Bank. This in turn pays an interest rate, or in some cases, when that interest rate is negative, charges the banks an interest rate.
What is the effect on the economy?
For most people, it may not be easy to see the impact of changing reference interest rates, but the truth is that it has a major impact on the lives of all of us.
Basically, these interest rates determined by the Central Bank cause changes in your everyday interest rates. It is through changes in these rates that a central bank influences the economy, with lower interest rates increasing the tendency to invest thanks to a decrease in the cost of borrowing.
On the other hand, with higher rates it becomes more difficult to invest, taking out a loan to start a business, buy a house or even a TV ends up becoming more expensive with higher interest rates.
We have for example quite recent situations, such as the case of the ECB, European Central Bank, having imposed negative rates to force commercial banks to make as many loans as possible, since depositing the money would be a loss.
Interest rate control is one of the main tools used by Central Banks and has relatively few negative consequences. It only requires a greater balance sheet to try to maintain price stability and market liquidity to ensure economic progression.
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