Central banks use monetary policy to manage economic fluctuations and achieve price stability, which means that inflation is low and stable. Central banks in many advanced economies set explicit inflation targets. Many developing countries also are moving to inflation targeting.
Central banks conduct monetary policy by adjusting the supply of money, usually through buying or selling securities in the open market. Open market operations affect short-term interest rates, which in turn influence longer-term rates and economic activity. When central banks lower interest rates, monetary policy is easing. When they raise interest rates, monetary policy is tightening.
After the global financial crisis that started in 2007, central banks in advanced economies eased monetary policy by reducing interest rates until short-term rates came close to zero, limiting options for additional cuts. Some central banks used unconventional monetary policies, buying long-term bonds to further lower long-term rates. Some even took short-term rates below zero. In response to the COVID-19 pandemic, central banks took actions to ease monetary policy, provide liquidity to markets, and maintain the flow of credit. To mitigate stress in currency and bond markets, many emerging market central banks used foreign exchange interventions, and for the first time, asset purchase programs. More recently, in response to rapidly growing inflation, central banks around the world have tightened monetary policy by increasing interest rates.
A country’s monetary policy is closely linked to its exchange rate regime. A country’s interest rates affect the value of its currency, so those with a fixed exchange rate will have less scope for an independent monetary policy than ones with a flexible exchange rate. A fully flexible exchange rate regime supports an effective inflation-targeting framework.
The global financial crisis of 2007-2009 showed that countries needed to identify and contain risks to the financial system as a whole. Many central banks adopted the use of prudential tools and established macroprudential policy frameworks to promote financial stability. Macroprudential tools are used to build buffers and contain vulnerabilities that make the financial system susceptible to shocks. This reduces the probability that shocks to the financial system disrupt the provision of financial services and cause serious negative consequences for the economy. Central banks are well placed to conduct macroprudential policy because they are able to analyze systemic risk and often are relatively independent and autonomous. Independence and autonomy are important because the institution responsible for macroprudential policy should be able to withstand political pressures and opposition from industry groups.
The IMF promotes the effectiveness of central banks through its policy advice, technical assistance, and data collection.
In bilateral policy advice, known as Article IV consultation, the IMF is in regular dialogue with country central banks. It may provide advice on establishing effective frameworks for monetary policy and macroprudential policy, as well as monetary policy actions.
As part of its financial surveillance, the IMF’s Financial Sector Assessment Program (FSAP) provides member countries with an evaluation of their financial systems and advice on managing financial stability risks. The assessments often are contained in technical notes, such as these for Finland, Netherlands, and Romania.
Technical assistance helps countries develop more effective institutions, legal frameworks, and capacity. It may entail monetary policy, exchange rate regimes, or macroprudential policies. It can also help countries move toward inflation targeting or improve central bank operations, such as open market operations and foreign exchange management.
The IMF’s Central Bank Transparency Code (CBT) helps central banks to guide their transparency practices, as a prerequisite for central bank independence. The CBT reviews, conducted by IMF staff, provide a view on central bank transparency and facilitate more effective dialogue between the central bank and its various stakeholders.
To inform policy development and research, the IMF works with its members to create and maintain databases. For example:
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The IMF tracks countries’ monetary policy arrangements (AREAER), central banks’ legal frameworks (CBLD), and monetary operations and instruments (MOID). |
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The IMF has an annual survey with details on macroprudential measures and institutions, enabling comparisons across countries and over time. |
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The IMF’s comprehensive historical database of macroprudential measures (iMaPP) integrates the latest survey information. IMF economists use the database to measure policy effects. It is also freely available to researchers. |
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The IMF has comprehensive, structured data on central banks’ direct market interventions. For example, IMF economists used the Central Bank Interventions Database (CBID) to track efforts to support financial markets during the COVID-19 pandemic. |
This page was last updated in January 2023
