How does a central bank control interest rates?

A central bank controls interest rates through various mechanisms. Firstly, it can employ open market operations, which involve buying or selling government securities to influence the supply of money in the economy. By purchasing securities, the central bank injects liquidity and lowers interest rates, stimulating borrowing and spending. Conversely, selling securities reduces money supply and increases interest rates. Secondly, central banks set reserve requirements for commercial banks, dictating the minimum percentage of deposits they must hold as reserves. Lowering reserve requirements releases more funds for lending, reducing interest rates, while higher requirements have the opposite effect. Another tool is the central bank's ability to directly lend funds to commercial banks. By adjusting the interest rate it charges these banks, the central bank can influence borrowing costs across the economy. Finally, central banks can use verbal or written guidance to influence market expectations and thereby indirectly impact interest rates. Overall, the central bank's actions aim to promote economic stability and support monetary policy objectives.