A central bank controls something known as monetary policy.
They do this by issuing the currency of its nation while providing services to its commercial banking sector.
Each country can only have one central bank (independent of government).
The central bank then provides credit to all commercial banks that operate within its jurisdiction.
Exploring Monetary Policy
Remember, monetary policy controls the flow of capital within an economy.
Furthermore, the flow of capital can impact economic growth and inflation.
The job of a central bank is to balance steady economic growth with a sustainable level of inflation.
Specifically, central banks use ‘monetary policy tools’ to balance these metrics.
A central bank will also start the process of tapering once economic conditions such as inflation and unemployment have started to improve.
Each central bank has their own dedicated website where you can find information on their monetary policy and objectives.
Supply And Demand
A population doesn’t have direct access to a central bank.
Instead, a central bank deals with commercial banks.
It’s through this relationship that central banks control the flow of capital.
This is critical for Forex traders to understand.
Because changing the supply/demand for capital can affect the price of the native currency.
The Flow Of Capital
Let’s look at an example.
A central bank decides to cut its benchmark interest rate.
Keep in mind that the benchmark interest rate is the cost charged to commercial banks for borrowing money.
The central bank makes this decision to increase the flow capital within its economy.
In this scenario, consumers would expect commercial banks to also cut their interest rates.
This makes it cheaper for consumers and businesses to access loans.
Usually, this helps fuel spending and economic growth.
The Major Central Banks
The most famous central bank is the Federal Reserve in the US.
They are responsible for setting the US benchmark interest rate and issuing new US Dollars into the economy.
Each major country has their own central bank. Typically, traders call these ‘major central banks’.
Below are the 8 major central banks:
- Federal Reserve
- Bank of England
- European Central Bank
- Bank of Canada
- Bank of Japan
- Reserve Bank of Australia
- Reserve Bank of New Zealand
- Swiss National Bank
What Is A Central Bank?
As a Forex trader, you need to pay close attention to the actions of central banks.
By doing so, you will encounter some highly profitable trading opportunities.
In fact, the entire Forex industry revolves around central bank interest rate decisions.
An increase – or hike – in the benchmark interest rate often results in traders buying the related currency.
Conversely, cutting the benchmark interest rate typically has the opposite effect.
If you plan to make an income from Forex, it’s critical that understand how central banks operate.
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