What are the main monetary policy tools used by central banks?

Central banks utilize a range of monetary policy tools to influence the economy, and among these, open market operations, the discount rate, and reserve requirements are the primary instruments.

Open market operations refer to the buying and selling of government securities in the open market. When a central bank buys securities, it injects liquidity into the economy, which can lower interest rates and encourage borrowing and spending. Conversely, selling securities can help absorb excess liquidity and raise interest rates, which can slow down the economy.

The discount rate is the interest rate charged by central banks on loans they give to commercial banks. By adjusting the discount rate, a central bank can influence other interest rates in the economy. A lower discount rate makes borrowing cheaper for banks, which can then pass on lower rates to consumers and businesses, stimulating economic activity.

Reserve requirements dictate the amount of funds that banks must hold in reserve and not lend out. Lowering reserve requirements allows banks to lend more, increasing the money supply and encouraging economic growth. Raising reserve requirements has the opposite effect, shrinking the money supply and potentially cooling down an overheated economy.

These tools directly target the money supply and interest rates, allowing central banks to manage inflation and support economic stability effectively. This understanding contrasts with the other options