Mechanism Analysis: How Central Banks Influence the Market through Monetary Policy

Core Points

• Monetary policy is the policy tool used by central banks to control the money supply and borrowing costs, directly affecting economic activity.
• By adjusting interest rates, implementing open market operations, and changing reserve requirements, the central bank can expand or contract the economy.
• Changes in monetary policy can affect the disposable income of individuals and businesses, thereby indirectly putting pressure on the prices of crypto assets.
• A loose monetary environment typically brings funding momentum to high-risk assets, while tightening policies can easily lead to liquidity contraction.

How the Crypto Market Feels About Changes in Monetary Policy

Market performance during the liquidity expansion period

When the central bank implements an expansionary monetary policy, the supply of money in the economy increases. By lowering interest rates and expanding the money supply, the public has more disposable income. In this environment, investors are more inclined to seek high-yield opportunities, including Bitcoin and other cryptocurrencies. Historical data shows that during such policy cycles, risk assets often experience opportunities for price increases.

Key Impact Chain:

• Interest rates decrease → Borrowing costs lower → Businesses and individuals tend to increase spending and investment
• Disposable income increases → Risk appetite rises → Capital inflow into crypto assets
• Market sentiment turns optimistic → trading volume increases → upward price pressure intensifies

Market Response During Periods of Tightening Liquidity

Conversely, when central banks adopt a contractionary monetary policy, the situation reverses completely. By raising interest rates and reducing the money supply, central banks attempt to slow down economic activity. Borrowing becomes more expensive, disposable income is constrained, and investors' risk tolerance decreases. The cryptocurrency market typically faces pressure from capital outflows, leading to a decline in prices.

Two Models of Monetary Policy

Expansionary policy: releasing liquidity

Expansionary monetary policy is typically implemented during periods of economic weakness or recession. The central bank's goal is to stimulate growth and promote employment.

How It Works: Lowering interest rates reduces borrowing costs, making companies more willing to expand production and invest, while consumers are also inclined to make large expenditures (such as buying homes or starting businesses). The result is an increase in overall demand and acceleration of economic activity.

Historical Case: 2008 Global Financial Crisis The Federal Reserve has taken aggressive expansion measures. In addition to significantly lowering policy interest rates, the Fed has also launched a quantitative easing program, purchasing large amounts of government bonds and mortgage-backed securities. These measures have significantly increased market liquidity and helped the economy recover from the recession.

Contractionary policy: curb inflation

Tight monetary policy is used to combat inflation. Central banks cool down an overheated economy by raising borrowing costs.

How it works: Raising interest rates increases borrowing costs, causing businesses and consumers to reduce spending and investment. Overall demand decreases, and the rate of price increase slows down. This is a “fever-reducing” therapy.

Historical Case: Inflation Control in the Early 1980s Faced with high inflation pressures, the Federal Reserve significantly raised policy interest rates. Although these measures successfully curbed the rise in inflation, they were accompanied by an increase in short-term unemployment rates. This indicates that the economic adjustments brought about by the policies are often accompanied by growing pains.

The Difference Between Monetary Policy and Fiscal Policy

Specific Operational Tools of the Central Bank

benchmark interest rate adjustment

This is the most direct tool. The central bank adjusts the interbank overnight lending rate, affecting the borrowing costs of commercial banks, which in turn transmits to the entire economy.

Open Market Operations

The central bank increases or decreases market liquidity by buying and selling assets such as government bonds. Purchasing assets releases liquidity, while selling assets withdraws liquidity.

Reserve Requirement Management

Lower the mandatory reserve requirement ratio for banks to release funds that can be used for lending; increasing the reserve requirement has the opposite effect.

Why the Cryptocurrency Market is Affected

Cryptographic assets may seem independent of the traditional financial system, but they are actually closely connected. Changes in monetary policy affect the risk appetite of the entire economy.

• Loose Cycle: Under low interest rate and environmental protection, traditional assets (such as bonds) have low yields, prompting investors to turn to high-risk assets like cryptocurrencies in search of returns.
• Contraction Cycle: In a high-interest rate environment, the attractiveness of safe assets such as bonds increases, making crypto assets relatively less favored.
• Expectation Effect: The market's anticipation of a policy shift often takes effect prior to the actual implementation.

Summary

Monetary policy is the lever through which central banks control the economy. By managing interest rates, money supply, and bank reserves, central banks can guide economic expansion or contraction. These seemingly macro policies ultimately influence the liquidity and price trends of risk assets like cryptocurrencies indirectly but significantly by altering the disposable income of individuals and businesses. Understanding the monetary policy cycle is a necessary foundation for investors to grasp market rhythms.