Monetary policy is like the set of rules and actions that a country's central bank (like the Federal Reserve in the United States) uses to control the money supply and interest rates.
It's a way for the central bank to help manage the economy, make sure there are enough jobs, and keep prices stable (not rising too fast or too slow).
There are two main types of monetary policy:
- Expansionary monetary policy: This is when the central bank wants to help the economy grow faster, usually because there aren't enough jobs or the economy is in a recession. They do this by lowering interest rates, which makes it cheaper for people and businesses to borrow money. This encourages spending and investment, which can help create jobs and boost the economy.
- Contractionary monetary policy: This is when the central bank wants to slow down the economy, usually because prices are rising too fast (inflation). They do this by raising interest rates, which makes it more expensive for people and businesses to borrow money. This can help reduce spending and investment, which can help keep inflation under control.
Central banks use different tools to implement monetary policy such as:
- Changing the interest rate they charge banks to borrow money.
- Buying or selling government bonds (and other assets)
- Changing the amount of money banks must keep in reserve.
By using these tools, the central bank can influence the money supply and interest rates in the economy, which ultimately impacts things like jobs, prices, and economic growth.
Understanding monetary policy is important because it affects our everyday lives, from the cost of borrowing money to buy a house or start a business to the prices we pay for goods and services.