Central bank decisions create market shifts and can offer traders numerous trading opportunities. But navigating those shifts requires an understanding of the context behind them, as well as effective risk management strategies.
Until the mid-20th century, most nations pegged their currencies to the gold standard, which limited how much money could be printed. Once that ended, governments could print more money to meet budget deficits and needs, but they soon ran into inflationary problems. The result was the creation of central banks, which were charged with maintaining the country’s currency and providing stable employment and prices.
One of the most significant challenges faced by central banks today is how to balance their goals. A central bank’s goal might be to control inflation, maintain a fixed exchange rate, or support the economy during recession. But achieving those goals can often be in conflict. In order for central banks to remain credible, they need to choose common goals that can be defended against critics.
Another challenge is managing asset booms and busts. Orthodox policy is to not deflate assets before they turn into busts for fear of triggering a recession, but to instead be prepared to provide liquidity in the wake of a bust.
Finally, a central bank must be careful not to lose sight of its goals in the face of innovations in financial markets. New derivatives, for example, can make markets volatile and can obscure the connection between the underlying economic trends that a central bank is trying to address.