Every country with its own currency has one: the Federal Reserve in the US, the European Central Bank in the euro area, the Czech National Bank in Czechia. People argue about what they do, but the job is narrower than the headlines suggest. A central bank sets one price, the interest rate on money held between banks, and it runs one balance sheet. Almost everything else follows from those two.
This module shows how both work. You'll move the policy rate and watch a mortgage payment respond, then buy and sell bonds on a central bank's books and see which numbers change. You'll also see why the big pile of bank reserves created since 2008 didn't turn into a pile of loans.
Start with the job description. The ECB says its primary objective is to maintain price stability, which it defines as 2% inflation over the medium term. The Czech National Bank says the same: price stability is its primary objective, with a 2% target. The Fed describes its monetary policy aims as full employment and stable prices. So the first job is keeping the value of money from drifting too fast, up or down.
The second job is less visible. Commercial banks hold accounts at the central bank, and those balances, called reserves, are how banks pay each other (module 1 showed reserves moving between Bank A and Bank B). Ordinary people and firms can't open one. The Bank of England puts it plainly: consumers don't have access to reserves accounts. So the central bank is the bank for banks.
The third job shows up in a panic. If a sound bank can't get funding anywhere else, the central bank can lend to it. Economists call this being the lender of last resort. At the Fed it runs through the discount window: banks in generally sound financial condition can borrow overnight or for up to 90 days, at a rate the Fed has set at the top of its target range. That makes it a backstop more than a bargain.
Banks end each day needing to settle with each other in reserves. Those with extra lend to those that are short, usually overnight. In the US, the rate on those overnight loans is the federal funds rate. The central bank steers it. One tool is the interest it pays banks on the reserves they hold with it: the Fed calls this interest on reserve balances and sets the rate itself.
Here's why that rate matters to you. A bank has no reason to lend to a customer for less than it can earn, risk-free, by leaving the money at the central bank. So the policy rate becomes the floor under the price of money. The Bank of England says banks' cost of funds is closely related to the interest rate paid on reserves, the policy rate. Loans are priced at that floor plus a spread for risk, costs and profit. Savings rates follow too, usually only in part.
The pass-through is loose. A 30-year mortgage depends on where banks and investors expect rates to be for years, so it follows long-term bond yields as well as the overnight rate. The simulator below uses a deliberately simple version, with every assumption on screen so you can change it.
Drag the policy rate and read down the chain. The starting point is the US effective federal funds rate, which averaged 3.75% in September 2026. The spread, pass-through and savings share are made up for the model, not measured. Change them and see how much the answer depends on them.
With the model's defaults, a policy rate one point higher lifts the mortgage rate by 0.8 points and the savings rate by 0.5 points. On a $300,000 loan over 30 years, a mortgage rate that is one point higher, 6.0% instead of 5.0%, adds $188 a month ($1,799 versus $1,610). A saver with $10,000 earns an extra $50 a year. Borrowers feel it more than savers because a loan is far bigger than a savings balance.
Now look at the real thing. The chart shows the three policy rates side by side. They're not identical tools: the Fed's line is the rate banks actually paid each other, which the Fed steers toward a target range. The ECB's is the rate it pays banks that park money with it overnight. The Czech line is the two-week repo rate, the Czech National Bank's main policy rate. Each is the anchor price in its own area.
Switch the start year to zoom in on the hiking and cutting since 2019. The Czech rate is drawn as steps, because it changes on specific dates and holds in between.
A few points to read off it. The Fed's effective rate was 5.26% in July 2007, 0.16% in December 2008 and 0.05% in April 2020. It reached 5.33% in August 2023 and averaged 3.75% in September 2026, up from 3.63% in August. The ECB's rate went below zero in June 2014 and sat at -0.5% from September 2019 until June 2022. Then it climbed to 4.0% by September 2023, came back to 2.0% by June 2025, and was 2.5% in October 2026. The Czech rate hit its record low in the series, 0.05%, in November 2012, was 7.0% from 23 June 2022 until December 2023, and has been 3.75% since 19 June 2026.
Notice that all three rose in 2026: the Fed's monthly average from 3.63% to 3.75%, the ECB from 2.0% in May to 2.5% by September, and the Czech repo rate from 3.5% to 3.75% in June. This module doesn't explain why. It shows the mechanism, which is the same whichever way rates are moving.
A central bank also has a balance sheet, like any bank. On the asset side sit mostly bonds. On the liability side sit paper money in circulation and the reserves it owes to banks. The Bank of England describes reserves as an IOU from the central bank to commercial banks.
When a central bank buys a bond, it doesn't pull cash from a vault. It pays by creating reserves. If the seller is a bank, the bank's bond turns into a reserve balance. If the seller is a pension fund or any other non-bank, the fund's bank gets the reserves and credits the fund with a new deposit. This is quantitative easing (QE). It matters most when the policy rate is already near zero, as it was in December 2008 (0.16%) and April 2020 (0.05%). The rate can't fall much further, so buying bonds is another way to ease. The Bank of England's explanation is that sellers rebalance into other assets, so asset prices rise and spending follows with a lag.
Reverse it and you get quantitative tightening (QT). The Fed announced in May 2022 that from 1 June 2022 it would let bonds mature without replacing all of them. The monthly caps started at $30 billion of Treasuries and $17.5 billion of agency debt and mortgage securities, then rose to $60 billion and $35 billion. As the bonds roll off, reserves and, when the counterparty is outside the banking system, deposits fall with them.
The simulator below runs both directions on a stripped-down set of books. The starting numbers are invented and not to scale. Try the same trade twice, once with a pension fund and once with a bank, and compare.
Three sets of books: the central bank, all commercial banks combined, and the public. Rows that changed on the last move are highlighted. Watch the four numbers at the top, especially bank loans.
Pick who sells, set an amount, and press "Buy bonds". Then try selling.
Three things to notice. First, who sells matters. When a pension fund sells, reserves and deposits both rise. When a bank sells, only the mix of its assets changes, and deposits stay put. Second, selling reverses it, so QT removes reserves and, with a non-bank buyer, deposits. Third, whichever you press, bank loans never move on their own.
Now the real balance sheet. In December 2007 the Fed's total assets averaged $886 billion and bank reserves with the Fed averaged $7 billion. By December 2008 the figures were $2,223 billion and $769 billion. Assets peaked at $8,950 billion in April 2022, and reserves peaked at $4.21 trillion in December 2021. In September 2026 the figures were $6,743 billion and $2.96 trillion.
In the simulator, a dollar of bonds sold removes exactly a dollar of reserves. The real balance sheet has other liabilities that also move, so the real series don't track each other one for one. Reserves rose from under 1% of the Fed's assets in December 2007 to 48.3% in December 2021, and were 43.8% in September 2026.
Total assets and the reserves banks hold with the Fed, in billions of dollars. Switch views to see reserves as a share of assets. The last full month in the data is September 2026.
A $4 trillion pile of reserves sounds like a $4 trillion pile of lending capacity. It isn't, and the reason is plumbing. Reserves exist only on the central bank's books, in accounts that banks hold. The Bank of England's 2014 paper says banks "cannot directly lend out reserves," because those banks can "use them to make payments to each other, but they cannot 'lend' them on to consumers in the economy, who do not hold reserves accounts."
Lending works the other way round, as module 1 showed. When a bank makes a loan, it creates a deposit. The same paper notes that when banks make additional loans, they are matched by extra deposits and the amount of reserves does not change. Press "Bank lends to a customer" in the simulator and watch: reserves stay where they were.
That's why QE can add trillions of reserves without forcing a surge in lending. The Bank of England's conclusion is that QE boosts broad money without directly leading to, or requiring, an increase in lending. What QE does do is change the price and quantity of assets people hold. What limits lending is what module 1 listed: expected profit, capital and demand from borrowers, all priced off the policy rate.
It sets the interest rate on money held between banks, runs a balance sheet of bonds and reserves, and lends to sound banks in a panic as lender of last resort. The ECB and the Czech National Bank target 2% inflation. The Fed's aims are full employment and stable prices.
The rate US banks charge each other for overnight loans of reserves. The Fed steers it, partly by setting the interest it pays on reserve balances. The effective rate averaged 3.75% in September 2026, after 5.33% in August 2023 and 0.05% in April 2020.
A central bank buying bonds and paying with newly created reserves. If the seller isn't a bank, the seller's bank also credits it with a new deposit. Fed assets went from $886 billion in December 2007 to a peak of $8,950 billion in April 2022, and were $6,743 billion in September 2026. Quantitative tightening runs it in reverse.
No. Reserves sit in accounts at the central bank that only banks can hold, so banks pay each other with them but can't pass them to customers. A bank loan creates a new deposit and leaves reserves unchanged, which is why trillions of dollars of QE reserves didn't force a surge in lending.