Monetary Policy
Monetary policy is the process by which a central bank manages the money supply and interest rates to achieve macroeconomic objectives such as price stability, full employment, and economic growth. It is one of the two principal tools of macroeconomic policy, the other being fiscal policy.[1]
Definition and objectives
Monetary policy refers to the actions taken by a central bank to influence the availability and cost of money and credit in the economy. Its primary objective in most countries is to maintain price stability—that is, to keep inflation low and stable—though many central banks also have mandates that include supporting employment and growth.[1]
Types
| Type | Measures | Purpose |
|---|---|---|
| Expansionary monetary policy | Lower interest rates, increase money supply. | Stimulate borrowing, spending, and investment. |
| Contractionary Monetary Policy | Raise interest rates, reduce money supply. | Cool the economy and reduce inflation. |
Tools
Central banks use several instruments to implement monetary policy:
- Deposit Reserve Ratio — the proportion of deposits banks must hold as reserves.
- Rediscount Rate — the rate at which banks can borrow from the central bank.
- Open Market Operations — the buying and selling of government securities.
- Interest on reserves and other policy rates.
- Unconventional tools, such as quantitative easing.
Transmission
Monetary policy affects the economy through several channels, including the interest rate channel, the credit channel, the exchange rate channel, and the expectations channel. Changes in the policy rate influence borrowing costs, asset prices, and the exchange rate, which in turn affect consumption, investment, and net exports.[1]