What does the "channel" or "corridor" system in central banks refer to?

The "channel" or "corridor" system in central banks primarily pertains to the framework that governs how central banks influence monetary policy by setting interest rates. This system consists of a specified range between the central bank's lending rate (the rate at which it lends to commercial banks) and its deposit rate (the rate at which it pays interest on reserves held by banks).

By establishing these two rates, central banks create a corridor within which market interest rates can fluctuate. The deposit rate provides a floor, as banks will not lend to one another at rates below this level because they can earn this interest simply by depositing their reserves with the central bank. Conversely, the lending rate serves as a ceiling, preventing bank lending rates from exceeding it. Therefore, the spread between the target interest rate and the deposit rate is crucial, as it determines the bandwidth in which the actual market rates will move, promoting effective liquidity management among banks and ensuring that monetary policy intentions are transmitted through the economy efficiently.

This framework enables central banks to control short-term interest rates and implement monetary policy effectively, making the understanding of this spread fundamental to comprehending the operational mechanics of central banks.