What role do central banks play in an economy?

Central banks play a crucial role in managing a country’s economic stability by controlling the amount of money circulating in the economy. This function is primarily carried out through various monetary policy tools, such as setting interest rates, conducting open market operations, and adjusting reserve requirements for commercial banks. By influencing the supply of money, central banks aim to achieve key economic objectives, such as controlling inflation, maintaining employment levels, and ensuring stable financial markets.

For instance, in times of economic downturn, a central bank might lower interest rates to encourage borrowing and investment, thereby increasing the money supply, which can stimulate economic growth. Conversely, to combat high inflation, a central bank may raise interest rates to reduce the money supply and cool down the economy. This central management of the money supply is essential to promote a balanced economic environment and ensure long-term financial stability.