Financial Times Guide to Bond and Money Markets, The

CHAPTER 16

CENTRAL BANKING INFLUENCE ON INTEREST RATES

To appreciate the influence of central banks on interest rates we need to first look at how money is created. It may surprise you to learn that, for the most part, money is not created by the actions of the central bank, it is mostly created by the commercial banks lending to people and business.

We then need to tackle the constraints on that money creation, which come largely from prudential self-restraint, with a helping hand from the central banking authorities. Because a commercial bank knows it is sensible to keep a proportion of the assets it owns in a highly liquid form, but at the same time knows that it is tempting to lend long term to gain higher interest, there is a tension ...