TREASURY CLASSROOM VOLUME 117

DECODING GLOBAL CONTEXT FROM INTEREST RATE POINT OF VIEW

Globally right now the central banks are on a verge of hiking interest rates in their economy. Now we are witnessing the era were guessing most things about the respective economy has become difficult. But yeah on the other front if we see the path from the first lockdown where all the economies were in a wait and watch situation and were waiting for their GDP results, inflation, fiscal and trade deficit results the central banks have to travel a long way And as expected the results have not supported the economy, so in that situation, the many central banks across the globe have come forward to revive their economy from the pandemic shocks.

Now let's understand how the central banks are supporting the economy.

Any central bank's balance sheet will include the asset and liabilities which will change according to the steps the central bank takes to revive the economy. The steps are taken to promote employment, controlling inflation and long-term interest rates.

A Central bank generally conducts OMO(Open market operations) to revive the economy, where it buys and sells securities according to the economy. As when it buys securities it generally releases money into the system and when it sells it sucks out money from the system. Also, central banks print money to buy the government debt to release money into the system, as by buying government bonds the central banks reduce the bond supply in the market and make the bond prices higher which in turn reduces the bond yields. Low bond yields translate into low rates making it easier for households to take a house or car loan it creates an illusion of wealth for households driving spending and spurring the economy.

Also, one of the major tools includes Operation twist(Buying and selling of securities simultaneously. In this generally central banks sell short-term securities and buy long-term securities in this way the central banks bring down the long-term yields). Operation twist is different from quantitative easing as it does not create a new money system. Instead, the money that central banks get by selling short term securities will be used to buy longer-term securities,

Another tool used by the central banks although this tool is more famous in developed nations economies. It is yield curve control. In this, the central banks generally target the longer-term rates and then buy or sell as many bonds as necessary to hit the target. Now to bring the longer- term yields down the central banks will set the longer-term interest rate target and buy as many bonds as necessary to achieve it. In the case, of Quantitative easing central banks focus on the quantities of bonds but in YCC the focus is on prices of bonds.

Above we have discussed tools used by the central banks to revive the economy from shocks like pandemic. But now when many central banks are of the view that the economy has been given a lot of liquidity. Now they are sucking excess liquidity from the market in the form of hiking interest rates and also reducing the balance sheet size by selling securities. But one cannot ignore the fact that selling securities puts pressure on the bond markets which could make the financial markets more volatile.

Like in the case of the federal reserve in their recent meeting they were sounding hawkish and now are on a verge of increasing interest rates majorly the central banks take decisions on sucking out liquidity in the system when they think that economy is experiencing full employment and excess inflation is building due to more liquidity and low rates.

Disclaimer- Only for informative purpose only