Low inflation is a positive scenario as it enables a country to maintain a stable economy and keep the value of local currency money.
For example, if a Central Bank wants to attain and keep exchange rate stability and stem capital outflow, the bank must implement a high interest rate policy such as increasing call market rates to a range of 20 to 30% from a regular level of 10% in most cases. A stable foreign exchange rate will prevent a deep contraction of domestic economic activity. The Central Bank can also encourage an expansion of bank lending to small and medium enterprises by expanding its credit facility to support local enterprises. By achieving its primordial goals of stablility and efficiency in the monetary and financial frameworks, the Central Bank makes its very important contribution to the growth of the local economy.
The Central Bank sets a base rate at which it transacts with other financial institutions. This interest rate then impacts on an array of interest rates set by commercial banks and building societies for their clients consisting of both borrowers and lenders. It also affects the price of financial assets including bonds and shares. The policy of decreasing or raising interest rates influences the level of spending in the economy. For instance, lower interest rates makes saving less attractive and borrowing more attractive. Lower interest rates can affect the consumers' and the firms' cash-flow. For example, a steep drop in interest rates reduces the income from savings and the interest payments due on loans. Borrowers also spend more of any extra money they have. The final effect of lower interest rates is to encourage higher spending in aggregate.
Lower interest rates can boost the prices of other assets such as houses. Higher house prices permit the home owners to extend their mortgages to finance higher consumption. Higher share prices increase the households' wealth also.
In addition, the main macroeconomic objectives of long-term growth and employment are achieved by monetary authorities through the judicious application of the appropriate monetary policy. Over the years, monetary authorities are focused on price stability by setting numerical targets for inflation over specific periods.
As a strategic move to set the base rates, the monetary authorities make a series of choices regarding the information used as the basis for short-term and longer-term monetary policy adjustments by giving weight and specific roles to crucial economic variables. This information is applied in setting the base rate for interest rates, the prevailing foreign exchange rate regime, the intermediate money supply targets, the preferred forecasting mechanisms and the prevailing indices of the prevailing conditions in the monetary sphere. Individual country assessments on the base rate vary in most respects. The financial variables which exert an important role at the strategic level include important targets such as money, credit and asset prices.
The main operating procedures which relate to the tactical level of policy implementation encompass the choice both of instruments and of operating objectives. The central bankers use major policy instruments such as official interest rates, market operations such as repurchase tenders, reserve requirements and specific direct controls like ceilings on loans and ceilings on bank deposits