Glossary
Central bank
A national institution that manages a country's currency, money supply and short-term interest rates, such as the Federal Reserve.
On this page
A central bank is the public institution responsible for a country's or region's money: it sets short-term interest rates, influences how much money and credit flow through the economy, supervises parts of the banking system and acts as a lender of last resort in a crisis. Examples include the US Federal Reserve, the European Central Bank, the Bank of Japan and the Bank of England. Few institutions move financial markets as much, because interest rates affect the value of nearly every asset.
What central banks do
- Monetary policy. Most central banks pursue price stability, often defined as an inflation target of 2%. The Fed has a dual mandate from Congress: maximum employment and stable prices.
- Set a policy rate. The Fed's Federal Open Market Committee sets a target range for the federal funds rate, the rate banks charge each other for overnight loans, and holds eight scheduled meetings a year.
- Manage the balance sheet. Buying bonds (quantitative easing) adds money to the system and pushes down longer-term yields; letting them run off (quantitative tightening) does the reverse.
- Provide emergency liquidity to banks and, at times, to wider markets, as in 2008 and 2020.
Why investors care
Higher rates raise borrowing costs, slow growth and reduce the present value of future earnings, which weighs especially on long-duration assets like growth stocks and long-term bonds. Lower rates generally do the opposite. Markets therefore react not just to decisions but to every hint about future policy, from statements and press conferences to the Fed's dot plot. Central banks also influence exchange rates, since higher rates tend to attract foreign capital.