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What Monetary Policy Is

What Is Monetary Policy?

Monetary policy is a collection of tools utilized by the country’s central bank to manage the overall quantity of money and encourage economic growth. They employ strategies like altering interest rates and altering the reserve requirements of banks.

In the United States, the Federal Reserve Bank implements the monetary policy with the dual purpose of achieving the highest level of employment while keeping the rate of inflation under control.

Understanding Monetary Policy

The policy of Monetary Policy is the management of the amount of money that is available to the economy and the channels through that new money is dispensed.

Economic statistics, such as Gross Domestic Product (GDP) as well as inflation rates, inflation as well as the growth rates of specific industries and sectors affect the monetary policy.

A central bank can change the rates of interest it charges for loans to national banks. If rates are rising or falling financial institutions alter rates for their clients such as home buyers or businesses.

In addition, it can purchase or sell government bonds as well as in order to improve rates for foreign exchange rates and modify how much cash banks must keep as reserves.

Types of Monetary Policy

Policies pertaining to money are considered either contractionary or expansionary based on the rate of growth or stagnation in the economy.


A contractionary policy raises interest rates, and also limits the money supply available to slow growth and reduce inflation. Inflation is when the costs of products and services within an economy increase and decrease the power of purchasing money.


In times of slowdowns or recession or recession, the expansionary policy can boost the economy’s activity. By lowering interest rates, saving becomes less attractive, and consumer expenditure and the amount of borrowing rise.

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Goals of Monetary Policy


Contractionary monetary policy is employed to reduce the level of inflation as well as reduce the amount of money that circulates within the economy.


A policy of monetary expansion reduces unemployment because a greater amount of money, as well as attractive rates of interest, boosts the growth of businesses and the employment market.

Exchange Rates

The exchange rates of domestic and foreign currencies are affected by the monetary policies. In the event of an increase in the quantity of money, the currency of the country will be less expensive than its foreign counterpart.

Tools of Monetary Policy

Open Market Operations

When it comes to OMO, also known as open market operations (OMO) In OMO, the Federal Reserve Bank buys bonds from investors or sells additional bonds to investors in order to increase the number of government securities outstanding and the amount of money that is available to the economy an entire.

The goal OMOs’ goal OMOs is to alter the reserve balances so that they can influence the rate of interest on short-term loans and also impact other interest rates.

Interest Rates

The central bank is able to alter the interest rates or the amount of collateral that it requires. For the U.S., this rate is called”the discount rate. Banks are able to lend more or less in a way that is dependent on the interest rate.

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The Federal Reserve commonly uses three strategies to manage monetary policy. These include reserve requirements and the discount rate as well as open market operation.

Reserve Requirements

Authorities can alter reserve requirements. Reserve requirements and the number of money banks have to hold in proportion to the deposits that their customers make in order to pay their obligations.

The reduction in reserve requirements will allow more capital for banks to provide loans or purchase other assets. By increasing the requirement, banks are able to limit lending and slow growth.

Monetary Policy in contrast to. Fiscal Policy

The policy of monetary policy is implemented through a central bank in order to ensure a stable economy, ensure that unemployment is low, safeguard the value of the currency, and ensure the pace of economic growth. Through manipulation of interest rates or reserves requirements or via open market operations central banks can influence borrowing or spending rates.

Fiscal policy is a different tool that is used by governments, but the central bank, but not by them. Although it is true that the Federal Reserve can influence the quantity of money that is available in the economy, the U.S. Treasury Department can create new money and apply different tax policies. It can send money, either in a direct or indirect way, to the economy to stimulate expenditure and stimulate growth.

Both fiscal and monetary tools were coordinated in the federal and Federal Reserve programs launched in response to the COVID-19 epidemic.

How Often Does Monetary Policy Change?

The Federal Open Market Committee of the Federal Reserve is a group 8 times per year to decide on changes to the country’s policy of monetary management. It is possible that the Federal Reserve may also act in times of crisis as it did during the economic crisis of 2007-2008 and the COVID-19 epidemic.

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How Has Monetary Policy Been Used to Curb Inflation In the United States?

A policy of contraction can slow economic growth and increase unemployment, but it is usually thought of as a necessity to level the market and keep prices within a certain range. In the midst of a double-digit rate of inflation in the 1980s during the 1980s, it was the case that the Federal Reserve raised its benchmark interest rate to 20 percent. While the effects of higher rates triggered an economic recession, inflation was slowed to the range between 3% and 4 percent over the next years.

Why Is the Federal Reserve Called a Lender of Last Resort?

The Fed also functions as a lender of the last option and provides banks liquid liquidity and regulatory oversight to stop them from failing and causing panic in the economy.

The Bottom Line

Monetary policy utilizes tools employed by the central bankers in order to help keep a nation’s economy in check while limiting unemployment and inflation. The expansion of monetary policy can stimulate an economy that is declining, while the contractionary monetary policy can slow down an economy that is experiencing inflation. The country’s monetary policy is usually linked to its fiscal policies of its.

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