Monetary policy

Monetary policyTermCar insurance×تأمين السياراتA contract that covers the cost of damage to your vehicle or injury to others, depending on the type of policy you hold.Open the term is the set of tools a central bankTermCentral bank×البنك المركزيThe government's bank, which controls the money supply, sets interest rates, and oversees all other banks in the country.Open the term uses to influence how much money circulates in an economy and what it costs to borrow. The main lever is the policy rate, the rate at which banks lend to one another overnight.

Around that sit two more. Reserve requirements set how much of every deposit a bank has to hold rather than lend on, which changes how much credit the banking system can create. Open market operations are the central bank buying or selling government securities, adding money to the system or taking it out.

The stated aim is much the same wherever one exists: prices that rise slowly and predictably, and an economy that grows without overheating.

Because a central bank does not set the rate on your loan, and yet it decides it. The policy rate is what banks pay to borrow from each other. Everything a customer is quoted sits on top of that: a mortgageTermMortgage×الرهن العقاريA loan secured by property, where the lender holds a claim on the house until the debt is repaid.Open the term, a car loan, the return on a term deposit, the rate on a card.

The transmission is not symmetrical, and the asymmetry is the part that costs money. When policy rates rise, the rate on variable borrowing tends to follow within a billing cycle, because the contract says it can. When policy rates fall, deposit rates follow slowly, because nothing obliges a bank to hurry. The saver waits and the borrower does not.

It also arrives late. A rate decision works through an economy over months rather than days, so by the time the effect is visible in prices, the conditions the bank was responding to are half a year old. Reading a rate announcement as a description of today is the common mistake. It is closer to a forecast of next year.

And it lands unevenly on people who read the same headline. A rate rise is felt immediately by anyone holding variable-rate debt, is a pay rise for anyone holding a large cash balance, and is close to invisible to someone with neither. That is why a single decision gets described as painful and irrelevant in the same week, by people who are both being accurate.

• The policy rate is a floor, not an offer. What a customer pays adds the bank's margin and its view of that customer's credit on top.
• A fixed-rate contract locks the rate for its term and a variable one passes every policy change through for the life of the loan. Which one you hold determines whether a rate decision is news or noise.
• Lending rates and deposit rates do not move together, and the gap between them is where a bank earns. Watching only one of the two gives half the picture.
• How much room a central bank actually has depends on the monetary systemTermMonetary system×النظام النقديThe arrangement that determines how a currency works in a country, and whether it is pegged to another currency, floats freely, or has collapsed.Open the term it operates under, which is a separate question from what its tools are.
• An announced policy and a delivered one are different things. Transmission runs through banks, and a bank that is unwilling to lend blunts a rate cut entirely.