Question

how the short term interset rate affect the central bank and the economy?

Answer 1

Influencing interest rates is one of the most important things central banks do, because interest rates have a profound effect on economic growth, job creation and inflation. Low interest rates, for example, allow businesses to borrow money cheaply, which then enables them to expand and hire more people. For consumers, low rates enable people to borrow money to buy homes and big-ticket items such as automobiles, furniture, appliances, vacations and other items that boost economic growth.

Conversely, high interest rates have the opposite effect, discouraging businesses and consumers from buying and investing. But sometimes central banks need to raise rates in order to keep the economy from overheating, which could lead to inflation. That could eventually push prices higher and make goods and services too expensive, which could then cause businesses and consumers to stop or curtail their spending, leading to slower economic growth and eventually a recession.

The U.S. Federal Reserve, for example, tries to set interest rates at an optimum level—not too high, not too low—in order to achieve its congressional mandate of maximum employment, low and stable inflation, and moderate long-term interest rates. Other major central banks—such as the European Central Bank, the Bank of England, and the Bank of Japan—pretty much seek the same thing for their respective economies.

They seek to influence interest rates outwardly through public pronouncements of their intentions, as well as through their dealings with banks and other important players in the financial markets in order to ensure that their intended policies become effective.