Monetary Policy

Financial Dictionary -> General Finance -> Monetary Policy

Keeping inflation down means in practice, that the level of demand in the economy, in money terms, must not grow any faster than that of the economy's production capacity. The level of demand in the economy as a whole can be influenced by the government's and federal bank's Monetary Policy. Monetary policy is a series of measures which involve changes in a country's interest rates, the supply of money and the availability of money.

The two most common stances in regards to monetary policy are an expansionary policy and the contractionary policy. All depending on what the government wants from its country. When expansion is in mind the government is looking to increase the money supply, but with a contractionary policy they are aiming to bring down the money supply.

If an economy is in a recession or crisis, with high unemployment and a general pessimism then the government will want to expand and get things going again. They'll do this by lowering interest rates. However when inflation is high they might implement a contractionary policy that raises interest rates to tackle the situation.

Interest rates can also affect the exchange rate. If they are high, the exchange rate may rise. This will then in turn affect international competitiveness. Businesses which find themselves uncompetitive because of a high exchange rate are under pressure and may fold if they cannot find some cost cutting measures.

The Federal Reserve is in charge of making a monetary policy in the United States and by influencing the effective cost of money, the Federal Reserve can change the sum of money that is used by the public and businesses operating in the country.

Monetary is the partner of Fiscal Policy, which is the process by which the government alters its spending to impact the economy.