Central banks are expected to keep a lid on inflation and inflation expectations on a continuous basis. In market parlance, they are expected to be "ahead of the curve" all the time.
A key feature in modern central banking is the power of central banks to set the price of money in the wholesale financial markets. Even in the developed, `free' market economies, the central bank is the arbiter of what borrowing/lending money should cost for a benchmark period-say overnight, a week, or a fortnight. This decision of the central bank is then transmitted through the financial markets-both wholesale and retail-to affect the saving, consuming, spending decisions/behavior of households and businesses, which in turn impacts the level of activity/inflation in the economy.
There is a process involved in transmitting the central bank's rate move to the overall economy and it involves a certain time lag. The pressure though is here and now. Central banks are expected to keep a lid on inflation and inflation expectations on a continuous basis. In market parlance, they are expected to be "ahead of the curve" all the time.
Given that central banks attempt to influence human behavior ultimately, the conduct of the monetary policy is as much a play on the psychology and perceptions of market participants as it is juggling around with economic numbers. Even the very perception that the central bank will move quickly to damp inflationary pressures, for instance, could cause changes in market interest rates, asset prices and exchange rates. Perceptions and expectations, therefore, play a major role in deciding not only monetary policy actions but also the outcome of such actions. |
