Monetary policy refers to the process by which a monetary authority controls the money supply in the economy. Usually it is the central bank that carries out the task, adjusting the amount of money available in order to spur economic growth, stabilize prices and exchange rates, and promote employment.
Primary Techniques To Control Monetary Policy:
One common technique is by ”increasing/decreasing the country’s monetary base”. Usually central banks do this by buying or selling bonds in exchange for money to be deposited in the central bank. In this process, the liquidity in the economy is increased.
Another way to control money supply is to limit the amount of assets that banks must leave with the central bank as reserves. By increasing the ”reserve ratio requirement”, banks have less liquid assets available for loans and more illiquid assets such as mortgages.
”Discount window lending” is also another way to control monetary policy. The central bank allows commercial banks to borrow reserves in exchange for collateral, making liquidity available for them in times of emergencies.
The fourth way in which money supply can be controlled is by adjusting ”interest rates”. When the central bank raises interest rates, the money supply contracts because there is more money used to pay for borrowing costs and less money to go around the economy.
There is also the ”currency board” or the option of pegging a country« Back to Glossary Index