Roles of the central bank in the economy:

1. Implementing Monetary Policy:

   • Setting interest rates
   • Controlling money supply

2. Maintaining Price Stability:

   • Managing inflation targets
   • Using tools like open market operations

3. Promoting Financial Stability:

   • Regulating and supervising banks
   • Acting as lender of last resort

4. Issuing Currency:

   • Printing and distributing money
   • Ensuring the integrity of the currency

5. Managing Foreign Exchange Reserves:

   • Intervening in currency markets
   • Maintaining international financial stability

6. Providing Economic Research and Advice:

   • Publishing economic forecasts
   • Advising government on economic matters

7. Operating Payment Systems:

   • Facilitating interbank transfers
   • Ensuring smooth functioning of financial markets

8. Setting Reserve Requirements:

   • Determining how much cash banks must hold

The central bank's actions significantly impact interest rates, inflation, employment, and overall economic growth.

Main tools of monetary policy:

1. Open Market Operations:

   • Buying or selling government securities to affect money supply
   • Primary tool for implementing monetary policy

2. Interest Rate Adjustments:

   • Changing the policy rate (e.g., federal funds rate in the US)
   • Influences borrowing costs throughout the economy

3. Reserve Requirements:

   • Setting the minimum amount of reserves banks must hold
   • Affects banks' lending capacity

4. Discount Rate:

   • The interest rate charged to commercial banks for loans from the central bank
   • Influences overall market interest rates

5. Quantitative Easing:

   • Large-scale asset purchases to increase money supply
   • Used in extraordinary circumstances

6. Forward Guidance:

   • Communication about future policy intentions
   • Influences market expectations

7. Bank Regulation:

   • Setting rules and guidelines for banking operations
   • Ensures stability of the financial system

Effects of monetary policy on inflation and employment:

Inflation:

1. Expansionary policy can increase inflation by boosting demand
2. Contractionary policy can decrease inflation by reducing money supply
3. Central banks often target a specific inflation rate (e.g., 2%)
4. Tools like interest rate adjustments directly impact borrowing and spending

Employment:

1. Lower interest rates can stimulate business investment and hiring
2. Increased money supply can boost economic activity and job creation
3. Stable prices create a favorable environment for long-term employment
4. There's often a short-term trade-off between inflation and unemployment (Phillips Curve)

Considerations:

• Time lags exist between policy implementation and economic effects
• Global economic conditions can influence policy effectiveness
• Structural economic issues may limit the impact of monetary policy on employment