Much of this section of the site has looked at the power over the markets that companies or individuals hold, but what about Central Banks? Are they not the biggest force in a market?
Central banks are organisations established by government to oversee the smooth running of an economy and often the regulation of financial services products and stock markets.
They are also usually charged with the task of money creation - the actual printing of bank notes. Though it must be admitted that this is a task that in the modern world would usually be outsourced to a specialist service provider.
It must go without saying that some central banks wield a much larger influence over the stock markets and economies of the world than others. This power generally relates to the size and influence of the home economy and stock exchange.
Therefore, some of the most influential banking institutions include the Bank of Japan, the Bank of England (United Kingdom), the Federal Reserve (USA), the European Central Bank (ECB) and the Bank of China.
In an effort to try and maintain balance in an economy, it is usually the job of the central bank to maintain inflation at an acceptable rate. This target rate would usually be determined by government. The bank would usually use interest rates as a tool to control growth and inflation rates.
Underlying interest rates - the rate borrowers pay on loans and savers receive on cash investments - can have a very major impact on economic factors such as consumer spending. For example, most families in developed economies will own a home but that home will be mortgaged to a bank or other lender. By making the monthly cost of interest payments higher or lower, a central bank can influence the amount of spare money in a family budget. Multiply this effect across millions of households and the power soon becomes clear!
The decision to alter interest rates is very major. The stock market will almost certainly react strongly to such moves and for a few hours or perhaps even a few days, prices will be quite volatile as different companies are reevaluated in light of this change in circumstances.
It ought to be pointed out that interest rate changes may have an impact on share prices immediately, but their impact on the 'wider' economy take much more time to become effective. In fact, it is widely believed that an interest rate adjustment may not be fully felt for between 18 months and 2 years!
This means that central bankers have the unenviable task of
trying to predict the state of the economy long into the future when
there are many imponderables and unknowns that can have a major impact. Worse, much of the information that they have available with which to base their decisions on is 'trailing data' - it is historic from several months ago. Clearly, this requires a quite amazing crystal ball - something which few of us possess.
For this reason, many economists are highly critical of decisions - it is easy to get decisions wrong in such circumstances - but would never wish to have to make these decisions themselves.
A lesser recognised tool for economic control is the supply of money into an economy and the rate at which 'old' money is retired. Some central banks still have the power to decide on the amount of funds an economy requires, though in many countries, politicians have wrested this decision from them. That means that politicians can make spending decisions that are independent of banker control.
Since the banking crisis of 2008 onwards, the role of a Central Bank has been much more powerful. In an attempt to prevent a huge recession, many central banks were forced to step in and begin buying assets in the markets.
This provided liquidity to keep asset prices stabilised but it can be - and has been argued - that the impact on the ordinary person has been limited, at best. This brief video of a Federal Reserve Inspector being interviewed will not exactly fill the viewer with confidence.
The general principles of quantitative easing (QE) are that central banks (such as the Federal Reserve, Bank of England, Bank of Japan and European Central Bank) are literally pumping money into their respective economies (via financial markets) to try and prevent a recession. It appears (in mid 2013) that the financial markets - especially bonds - have become reliant on these purchases and that it will not be easy to end the monthly injections without causing a major shock to stock and bond markets around the world. In other words, the recession being prevented will, if it happens, probably be bigger than the original feared one.
Money supply is a very complicated topic and even with the experience in finance that we have, your authors are not able to explain it in full. If we could, you would be asleep already...
To read more about the many different powers that have a major impact on the movements of a stock exchange, please visit the following pages: