Central bank policy is the set of decisions made by a central bank with regard to interest rates, and often other types of policies as well. These decisions aim to influence dimensions of macroeconomic activity like prices and inflation, output, employment and sometimes designated monetary aggregates. Central banks normally exert whatever influences they have over these magnitudes through their setting of short-term interest rates.
For example, by supplying money markets with ample liquidity during times of stress (like after the stock market and housing busts in recent years) or by allowing its bank reserves to rise and fall on a regular basis (called “repo operations”). The traditional story is that changes in the central bank’s policy rate are transmitted to other interest rates through a mechanism that involves banks increasing their loans and investments when reserves are plentiful/less costly and cutting back on them when they become scarce/more costly. However, there is no empirical evidence that this transmission mechanism actually works in practice.
Moreover, the more central banks are focused on their inflation target the more they have to trade off between stabilizing the economy in the short run and achieving the target in the long run. For this reason many central banks use a flexible inflation target.
Ideally, the broad objectives of financial agencies should be specified in legislation and the broad modalities of accountability for these agencies should also be publicly disclosed. For example, the procedures for appointment, terms of office and any general criteria for removal of the heads and members of their governing bodies should be publicized.