The central bank's tools

A central bank does not lend to individuals. Yet each of its decisions ends up in your loan, your savings, your prices.

It has five main tools. The first, and best known: the policy rate.

It is the price at which banks can deposit or borrow money with it, for a single day.

When this price rises, banks borrow from each other at a higher cost. And they lend at a higher cost to everyone.

For the example, a two hundred thousand euro loan. One point more means nearly two thousand euros of extra interest in the first year.

But the policy rate only touches very short-term money. Twenty-year loans mostly follow long-term rates.

Hence the second tool: quantitative easing. The central bank buys bonds, massively.

A one hundred euro bond pays two euros a year: two per cent. If the purchases push its price to one hundred and five euros…

… the same two euros now yield only one point nine per cent. Buying pushes long-term rates down.

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The third tool is the opposite: quantitative tightening. The central bank lets its bonds mature, without replacing them.

No spectacular announcement, no brutal selling. It is far more discreet. But long-term rates gently rise.

Fourth tool, the strangest: talking. It is called forward guidance.

The central bank announces: our rates will stay low for a long time. Markets believe it, and long-term rates fall straight away.

It acts without acting. One sentence is sometimes worth billions in purchases. Provided it is believed.

And a broken promise costs dear: next time, markets listen less.

Fifth tool: reserve requirements. Each bank must keep a share of its deposits at the central bank.

In the euro area, this share is small: one per cent. In the United States, it even fell to zero in two thousand twenty.

But in emerging economies, like China, it is still often changed to slow down or boost credit.

The twist: none of these tools directly creates growth. They change the price of money, and so behaviour.

Making credit dear to calm prices. Or cheap to revive the economy. With effects that often take a year or two to show.

So when a central bank speaks, listen. Your next loan often starts in its press release.