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Monetary Policy

Monetary policy is the actions of the government, a monetary authority, currency board or the central bank of a country to establish the size and rate of development of the money supply which, as a result, affects the interest rates. The monetary authority controls the availability, supply and the cost of the money or the rate of interest, to be able to attain a specific objective geared towards the growth, development and stability of the economy.

Monetary policy can be termed as either being a contractionary or an expansionary policy whereby contractionary policy decreases the total supply of money, or increases the interest rate, and the expansionary policy increases the total money supply, or decreases the interest rate. This is in light to the relationship created between the rates of interest, the price at which the money can be borrowed and the total supply of the money in an economy.

Moreover, the monetary policies can be depicted into three broad senses; a policy is termed as accommodative if the interest rates influenced by the monetary authorities are geared towards creating an economic growth. They are described as tight if the intention is to reduce inflation. Finally, they are termed as neutral if the main purpose of the interest rates is neither to combat inflation nor create any growth.

Monetary Policy tools

The main function of monetary policies is to influence an economy’s outcome to combat inflation or to create a sustainable economic growth. To contract the money supply, the monetary authority can increase interest rates, reduce the monetary base and increase the requirements of the reserves.

Interest rates

Monetary supply can be contracted in some way by increasing the nominal interest rates. Open market operations is the basis tool of monetary policy which entails managing the amount of money by buying and selling varied credit instruments, currencies or commodities. Depending on whether it is buying or selling, it results in a base currency coming into or exiting the market circulation.

Reserve requirements

The Federal Reserve exerts regulations over banks on the amount of total assets they ought to hold in their reserve. In essence, banks are allowed to hold a small part of their assets as immediate cash available, while the rest is invested in illiquid assets such as loans and mortgages. This aims at altering the amount of total assets held as liquid available cash, thus altering the accessibility of loanable funds.

Monetary base

Equally, by altering the size of the monetary base it implement monetary policies because it directly alters the quantity of money circulating in the economy. Federal Reserves can apply open market operations, to be able to alter the monetary base. For instance, the Reserve can purchase or sell bonds, in exchange of hard currency. Therefore, collecting or reimbursing this hard currency from and to the economy alters the quantity of currency circulating, ultimately altering the monetary base.

Types of monetary policies

Practically, all kinds of monetary policy, also known as monetary regimes, entail altering the quantity of base currency circulating in the economy. An open market operation is one type where the Fed Reserves alter the liquidity of the base currency through open buying and selling of debt and credit instruments. The different types of monetary policies are distinguished by the set of instruments and variables that are set and used to attain the goals of either contracting or expanding the supply of money in the economy.

The other types of monetary policies include inflation targeting, price level targeting, monetary aggregates and fixed exchange rates. Conversely, price level targeting focuses on the monetary quantities while the fixed exchange rate focuses on maintaining a fixed exchange rate with a foreign currency.

Tags: bank, cash, credit, government, interest rates, liquidity, loan, market, money, mortgage, policy, price

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