How does a central bank primarily influence interest rates?

The central bank primarily influences interest rates through open market operations. This method involves buying or selling government securities in the open market, which directly affects the money supply in the economy. When the central bank buys securities, it injects money into the banking system, increasing the amount of reserves banks hold. This additional liquidity typically leads to lower interest rates since banks have more money to lend. Conversely, when the central bank sells securities, it takes money out of circulation, reducing the reserves available to banks and often resulting in higher interest rates as the supply of loanable funds decreases.

Open market operations are a critical tool in the central bank's monetary policy toolbox because they allow for fine-tuned adjustments to the economy's liquidity and, consequently, the overall level of interest rates. This mechanism helps the central bank achieve its goals related to inflation and employment, making it a fundamental component of macroeconomic management.